Partnership Status of LLC 4
Under the so-called "check-the-box" rules in effect since 1997, a non-corporate domestic organization with more than one member is treated as a partnership unless it elects to be classified as an association (i.e., a corporation). Reg. §301.7701-3(b)(1)(i).
A number of analytical steps must be taken to reach this conclusion. First, it must be determined that the organization in question is a separate "entity" for federal tax purposes. The "check-the-box" rules (the "Regulations") apply only to separate entities. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law, and does not necessarily depend on whether the organization is recognized as an entity under local law. See, Reg. §301.7701-1(a)(1). Joint undertakings not recognized as entities under local law, for example, may be treated as entities for federal tax purposes. However, there is apparently a presumption that local law entities will be recognized for tax purposes. The only examples given in the Regulations of local law entities not recognized as separate entities for federal tax purposes are an organization wholly owned by a State, and a tribe incorporated under the Indian Reorganization Act of 1934 or similar statute. In addition, the Regulations note that certain organizations with a single owner can choose to be recognized or disregarded as entities. Reg. §301.7701-1(a)(2)-(4). In the scenario under consideration, the LLC is represented to be formed under the laws of the State of Nevada. It is also represented that the entity will have at least two members, a preferred member and one or more non-preferred members. Therefore, it is clear that the LLC will be treated as a separate entity for federal tax purposes.
The next step under the Regulations is to determine whether the LLC is a "business entity." The Regulations define this term as any entity recognized for federal tax purposes that is not properly classified as trust or otherwise subject to special treatment under the Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. Reg. §301.7701-2(a). Thus, the LLC is a business entity and, since it has two or more members, is classifiable for federal tax purposes as either a corporation or a partnership.
The next step in the analysis is to determine whether the LLC is an "eligible entity" permitted to elect its tax classification. Corporations (as defined in Reg. §301.7701-2(b)) are not eligible entities and must be treated as corporations. Specifically, an "eligible entity" is a business entity that is not classified as corporation under Regs. §301.7701-2(b)(1), (3),(4),(5),(6),(7) or (8). See, Reg. §3.01.7701-3(a). These provisions list certain entities taxable as corporations for federal tax purposes. Since the LLC is not listed in any of these provisions, it is an "eligible entity" under the regulatory scheme.
Finally, the Regulations provide that an eligible entity having two or more members may elect to be classified as either an association or a partnership for tax purposes. Reg. §301.7701-3(a). If the entity does not make an election, it will be classified according to the default classification system. A domestic eligible entity, such as the LLC in the present case, will automatically be classified as a partnership if it has two or more members. Reg. §301.77013(b)(1)(i). Therefore, the LLC will be treated as a partnership for federal tax purposes.