IRS issues Prop. Regs. on series LLCs and cell companies.

• Author: Dell, Michael
• Position: Limited liability companies

The IRS has issued proposed regulations that would treat, for federal tax purposes, a series of a domestic series limited liability company (LLC), a cell of a domestic cell company, and a foreign series or cell that conducts an insurance business as an entity formed under local law, regardless of whether the entity is treated as a juridical person for local law purposes (REG-119921-09). Subject to a generous transition rule, these proposed regulations will generally become effective when they are published as final regulations in the Federal Register.

Background

Series LLCs were first introduced in Delaware in 1996, and since then a number of states have enacted statutes to create entities, such as LLCs, that may establish series. These statutes are often referred to as series LLC statutes. In addition, certain jurisdictions have enacted statutes providing for entities similar to a series LLC. For example, certain statutes provide for the chartering of a legal entity (or the establishment of cells) under a structure commonly known as a protected cell company, a segregated account company, or a segregated portfolio company (cell company).

The preamble to the proposed regulations provides background on series LLCs:

In general, series LLC statutes provide that a limited liability company may establish separate series. Although series of a series LLC generally are not treated as separate entities for state law purposes and, thus, cannot have members, each series has "associated" with it specified members, assets, rights, obligations, and investment objectives or business purposes. Members' association with one or more particular series is comparable to direct ownership by the members in such series, in that their rights, duties, and powers with respect to the series are direct and specifically identified. If the conditions enumerated in the relevant statute are satisfied, the debts, liabilities, and obligations of one series generally are enforceable only against the assets of that series and not against assets of other series or of the series LLC. The insurance codes of many states and foreign jurisdictions also have statutes allowing for the creation of a protected cell company, which is a legal entity with multiple accounts or cells. With a protected cell company, assets placed within a cell are statutorily protected from the creditors of any other cell. In addition, while the cells will frequently issue stock (typically, a preferred stock of the protected cell company that is based on the performance of the specific cell), they are not treated as legal entities distinct from the protected cell company.

In Notice 2008-19, the IRS requested comments on proposed guidance to address issues that arise if protected cell arrangements entered into by a cell are insurance for federal tax purposes--specifically (1) the status of such a cell as an insurance company and (2) some of the consequences of a cell's status as an insurance company.

In the preamble to the proposed regulations, the IRS and Treasury note their general agreement with the recommendation that series and cells should be treated as separate entities for federal tax purposes if formed under a statute with provisions similar to those governing the series LLC in effect in several states.

Prop. Regs.

Under the proposed regulations, a series organized or established under the laws of the United States or of any state, whether a juridical person for local law purposes, would be treated as an entity formed under local law. In addition, a series organized or established under the laws of a foreign jurisdiction would be treated as an entity formed under local law if the arrangements and other activities of the series, if conducted by a domestic company, would result in classification as an insurance company under Secs. 816(a) or 831(c).

The determination of whether a series that is treated as a local law entity under the proposed regulations is recognized as a separate entity for federal tax purposes would be made under Regs...