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Partnership Tax Bulletin (January 1999)

IRS Provides Additional Guidance
Regarding Single Member Entities




By Brian Wainwright, a tax partner in the Palo Alto office of Pillsbury Winthrop Shaw Pittman LLP. If you have or can obtain the Acrobat Reader, you may wish to download the printed versions of the bulletin containing this article, a 120K pdf file, or of Revenue Ruling 99-5, Revenue Ruling 99-6 or Notice 99-6.

See Internal Revenue Service Adopts "Check-the-Box" Classification Regulations (December 1996) for a discussion of the "check-the-box" rules promulgated in Treasury Decision 8697, a 79K pdf file.

This bulletin concerning recent tax law developments is part of the Pillsbury Winthrop Shaw Pittman LLP Tax Page, a World Wide Web demonstration project. Comments are welcome on the design or content of this material.


Under the entity classification regulations, the so-called "check-the-box" rules, single-owner pass-through entities (e.g., limited liability companies ("LLCs")) are disregarded for federal tax purposes. The assets, liabilities and operations of the single-member LLC are treated as assets, liabilities and operations of its owner, resulting in a sole proprietorship where the owner is an individual, or a branch or division where the owner is a corporation. Proc.& Admin.Regs. § 301.7701-3.

In Revenue Rulings 99-5 and 99-6 the Internal Revenue Service ("IRS") discusses the federal income tax consequences of a single-member, disregarded LLC acquiring a second member and of a two-member LLC becoming a single-member LLC. In addition, in Notice 99-6 the IRS provides two temporary safe harbors regarding employment tax reporting and payment compliance by certain disregarded entities, including single-member LLCs, and invites comment on various aspects of application of the federal employment tax regime to these entities.

Revenue Ruling 99-5

This ruling deals with a single-member LLC owned by A holding only capital assets or property used in a trade or business with no liabilities. The LLC has not elected to be classified as an association taxable as a corporation and so is disregarded for federal tax purposes. In situation 1, A sells 50 percent of his interest in the LLC to B for $5,000. In situation 2, B contributes $10,000 to the LLC in exchange for a 50 percent interest; the LLC uses the $10,000 in its business.

    Situation 1

The IRS holding in situation 1 is that, because A is considered to hold directly all of the LLC's assets, A is treated as selling a 50 percent undivided interest in each of those assets to B for a total of $5,000. A and B are then treated as contributing their 50 percent undivided interests to the LLC (a new entity for federal tax purposes) in exchange for 50 percent interests in the LLC. A recognizes gain or loss on the deemed asset sale to B. I.R.C. § 1001. Neither A nor B recognizes gain or loss on their deemed asset contribution to the LLC. I.R.C. § 721.

A's basis for its LLC interest is equal to 50 percent of A's prior basis for all the LLC assets; B's basis for its LLC interest is $5,000, the price deemed paid to A by B for B's 50 percent undivided interest in the LLC assets. I.R.C. § 722. Because A's deemed asset transfer involves only capital assets and property used in a trade or business, A's holding period for its LLC interest includes A's holding period for the assets. I.R.C. 1223(1). B's holding period for its LLC interest begins the day after B's deemed asset purchase from A. I.R.C. 1223(1); Rev.Rul. 66-7, 1966-1 C.B. 188.

The "new" LLC's basis for each asset is the sum of A's basis for A's 50 percent undivided interest in that asset and B's basis for B's 50 percent undivided interest in that asset. I.R.C. 723. The LLC has a split holding period for each asset, since it inherits A's and B's respective holding periods for their 50 percent undivided interests in each asset. I.R.C. 1223(2).

    Situation 2

A "new" LLC is created by B's contribution of $10,000 in exchange for a 50 percent LLC interest. A is treated as transferring all the assets held by the "old" LLC to the "new" LLC in exchange for the other 50 percent LLC interest. A recognizes no gain or loss on the deemed asset contribution, has a basis for the LLC interest equal to A's former basis in the "old" LLC assets and has a holding period for the "new" LLC interest which includes the holding period for the "old" LLC assets (again because the "old" LLC held only capital assets and property used in a trade or business). I.R.C. §§ 721, 722, 1223(1). The "new" LLC has a basis in the assets deemed contributed by A equal to A's former basis in those assets and a holding period for those assets which includes A's prior holding period. I.R.C. §§ 723, 1223(2). B recognizes no gain or loss on B's contribution of $10,000 to the LLC, has a basis of $10,000 for its LLC interest and a holding period for that interest beginning the day after the contribution. I.R.C. §§ 721, 722; Rev.Rul. 66-7, 1966-1 C.B. 188.

Revenue Ruling 99-6

This ruling deals with a two-member LLC which is classified as a partnership for federal income tax purposes. The LLC holds no unrealized receivables or substantially appreciated inventory and has no liabilities. In situation 1, one of the members, A, sells all of A's 50 percent interest in the LLC to the other 50 percent member, B, for $10,000 so that following the sale, the LLC has but one member. In situation 2, the LLC's two members, C and D, sell their respective LLC interests to a third party, E, for $10,000 each. In both situations, following the transaction the LLC does not elect to be classified as an association taxable as a corporation.

    Situation 1

The IRS holds in situation 1 that A recognizes gain or loss on A's sale of the LLC interest. I.R.C. § 741. However, in determining B's federal income tax consequences, the IRS treats the transaction as if the LLC had liquidated, distributing a 50 percent undivided interest in each of its assets to A and B, and then B had purchased A's 50 percent undivided interest in those assets for $10,000. Edwin E. McCauslen v. Commissioner, 45 T.C. 588 (1966); Rev.Rul. 67-65, 1967-1 C.B. 168. B recognizes gain or loss on the deemed transfer of the 50 percent undivided interest in the LLC assets to B in liquidation of the LLC to the extent required by Internal Revenue Code section 731. B will have a split basis and holding period for each asset because a 50 percent undivided interest in each asset is treated as acquired upon liquidation of the LLC and the other 50 percent undivided interest treated as purchased from A for an aggregate of $10,000. I.R.C. §§ 731, 732, 1012; Rev.Rul. 66-7, 1966-1 C.B. 188.

    Situation 2

In situation 2, C and D each recognizes gain or loss on the sale of the LLC interest. Again, in determing E's federal income tax consequences, the LLC is treated as making a liquidating distribution to C and D and E is then treated as purchasing all the LLC assets from C and D. E thus has a basis for those assets equal to the $20,000 deemed paid and a holding period for those assets beginning the day after the purchase. I.R.C. § 1012; Rev.Rul. 66-7, 1966-1 C.B. 188.

Notice 99-6

In Notice 99-6, the IRS first observes that "qualified subchapter S subsidiaries," "qualified REIT subsidiaries" and single-owner pass-through entities are disregarded for all federal tax purposes, including employment taxes. Where a disregarded entity is an "employer" under the federal employment tax rules, its owner must satisfy any reporting and payment obligations under those rules. However, the IRS also notes that many taxpayers have incorrectly interpreted the disregarded entity rules as applying only for federal income tax purposes and that even taxpayers correctly interpretting the rules have encountered difficulty in their application in specific circumstances.

The IRS will temporarily permit taxpayers to satisfy employment tax requirements concerning disregarded entities in one of two ways. First, the owner of the disregarded entity can calculate, report and pay federal employment taxes with respect to employees of the disregarded entity under the owner's name and taxpayer identification number as if those employees were employed directly by the owner. Second, the disregarded entity can separately calculate, report and pay federal employment taxes with respect to its own employees under its own name and taxpayer identification number. The IRS reminds taxpayers utilizing the second method that the disregarded entity's owner remains ultimately responsible for federal employment tax obligations concerning the disregarded entity's employees. An owner of multiple disregarded entities can choose the first method for some of those entities and the second method for others. Further, an owner may switch from the second method to the first method for a succeeding taxable year. However, IRS consent is required to switch from the first method to the second.

The IRS also invites comment on the following federal employment tax issues concerning disregarded entities:

  • any increase or decrease in the administrative burden on taxpayers created by a system of filing employment tax returns under the owner's name and taxpayer identification number where employees are actually employed by a state law entity that is disregarded as an entity separate from its owner for federal tax purposes,

  • whether different rules should apply to newly formed disregarded entities with no previous employment tax history as opposed to entities in existence prior to the time when they became disregarded,

  • different results (both in amount of tax, type of tax and time and method of deposits) that arise from filing as one employer as compared to filing as separate employers,

  • appropriate methods for notifying the service center about changes in employment tax obligations when an entity's status as a disregarded entity changes,

  • possible issues arising in situations where the owner or the disregarded entity is formed or domiciled in a country other than the United States,

  • additional issues relating to employment taxes and disregarded entities including, but not limited to, confusion for employees, employers and state and federal agencies resulting from a single entity reporting structure for employment tax purposes and

  • whether any guidance issued should also apply to qualified REIT subsidiaries (as defined in Internal Revenue Code 856(i)).

Finally, the IRS invites comments on certain disregarded entity issues arising outside the employment tax area:

  • information reporting on IRS Form 1099s issued by, or with respect to, disregarded entities and their owners and

  • issues related to qualified or nonqualified deferred compensation plans, fringe benefit and welfare plans and other compensation arrangements.


Text of Revenue Ruling 99-5

Section 721 – Nonrecognition of Gain or Loss on Contribution

26 CFR § 1.721-1: Nonrecognition of gain or loss on contribution.

(Also §§ 722, 723, 1001, 1012, 1223, 7701; 1.1223-1, 301.7701-3.)

    Issue

What are the federal income tax consequences when a single member domestic limited liability company (LLC) that is disregarded for federal tax purposes as an entity separate from its owner under § 301.7701-3 of the Procedure and Administration Regulations becomes an entity with more than one owner that is classified as a partnership for federal tax purposes?

    Facts

In each of the following two situations, an LLC is formed and operates in a state which permits an LLC to have a single owner. Each LLC has a single owner, A, and is disregarded as an entity separate from its owner for federal tax purposes under § 301.7701-3. In both situations, the LLC would not be treated as an investment company (within the meaning of § 351) if it were incorporated. All of the assets held by each LLC are capital assets or property described in § 1231. For the sake of simplicity, it is assumed that neither LLC is liable for any indebtedness, nor are the assets of the LLCs subject to any indebtedness.

Situation 1. B, who is not related to A, purchases 50% of A's ownership interest in the LLC for $5,000. A does not contribute any portion of the $5,000 to the LLC. A and B continue to operate the business of the LLC as co-owners of the LLC.

Situation 2. B, who is not related to A, contributes $10,000 to the LLC in exchange for a 50% ownership interest in the LLC. The LLC uses all of the contributed cash in its business. A and B continue to operate the business of the LLC as co-owners of the LLC.

After the sale, in both situations, no entity classification election is made under § 301.7701-3(c) to treat the LLC as an association for federal tax purposes.

    Law and Analysis

Section 721(a) generally provides that no gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.

Section 722 provides that the basis of an interest in a partnership acquired by a contribution of property, including money, to the partnership shall be the amount of the money and the adjusted basis of the property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under § 721(b) to the contributing partner at such time.

Section 723 provides that the basis of property contributed to a partnership by a partner shall be the adjusted basis of the property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under § 721(b) to the contributing partner at such time.

Section 1001(a) provides that the gain or loss from the sale or other disposition of property shall be the difference between the amount realized therefrom and the adjusted basis provided in § 1011.

Section 1223(1) provides that, in determining the holding period of a taxpayer who receives property in an exchange, there shall be included the period for which the taxpayer held the property exchanged if the property has the same basis in whole or in part in the taxpayer's hands as the property exchanged, and the property exchanged at the time of the exchange was a capital asset or property described in § 1231.

Section 1223(2) provides that, regardless of how a property is acquired, in determining the holding period of a taxpayer who holds the property, there shall be included the period for which such property was held by any other person if the property has the same basis in whole or in part in the taxpayer's hands as it would have in the hands of such other person.

    Holding(s)

Situation 1. In this situation, the LLC, which, for federal tax purposes, is disregarded as an entity separate from its owner, is converted to a partnership when the new member, B, purchases an interest in the disregarded entity from the owner, A. B's purchase of 50% of A's ownership interest in the LLC is treated as the purchase of a 50% interest in each of the LLC's assets, which are treated as held directly by A for federal tax purposes. Immediately thereafter, A and B are treated as contributing their respective interests in those assets to a partnership in exchange for ownership interests in the partnership.

Under § 1001, A recognizes gain or loss from the deemed sale of the 50% interest in each asset of the LLC to B.

Under § 721(a), no gain or loss is recognized by A or B as a result of the conversion of the disregarded entity to a partnership. Under § 722, B's basis in the partnership interest is equal to $5,000, the amount paid by B to A for the assets which B is deemed to contribute to the newly-created partnership. A's basis in the partnership interest is equal to A's basis in A's 50% share of the assets of the LLC.

Under § 723, the basis of the property treated as contributed to the partnership by A and B is the adjusted basis of that property in A's and B's hands immediately after the deemed sale. Under § 1223(1), A's holding period for the partnership interest received includes A's holding period in the capital assets and property described in § 1231 held by the LLC when it converted from an entity that was disregarded as an entity separate from A to a partnership. B's holding period for the partnership interest begins on the day following the date of B's purchase of the LLC interest from A. See Rev. Rul. 66-7, 1966-1 C.B. 188, which provides that the holding period of a purchased asset is computed by excluding the date on which the asset is acquired. Under § 1223(2), the partnership's holding period for the assets deemed transferred to it includes A's and B's holding periods for such assets.

Situation 2. In this situation, the LLC is converted from an entity that is disregarded as an entity separate from its owner to a partnership when a new member, B, contributes cash to the LLC. B's contribution is treated as a contribution to a partnership in exchange for an ownership interest in the partnership. A is treated as contributing all of the assets of the LLC to the partnership in exchange for a partnership interest.

Under § 721(a), no gain or loss is recognized by A or B as a result of the conversion of the disregarded entity to a partnership.

Under § 722, B's basis in the partnership interest is equal to $10,000, the amount of cash contributed to the partnership. A's basis in the partnership interest is equal to A's basis in the assets of the LLC which A was treated as contributing to the newly-created partnership.

Under § 723, the basis of the property contributed to the partnership by A is the adjusted basis of that property in A's hands. The basis of the property contributed to the partnership by B is $10,000, the amount of cash contributed to the partnership.

Under § 1223(1), A's holding period for the partnership interest received includes A's holding period in the capital and § 1231 assets deemed contributed when the disregarded entity converted to a partnership. B's holding period for the partnership interest begins on the day following the date of B's contribution of money to the LLC. Under § 1223(2), the partnership's holding period for the assets transferred to it includes A's holding period.

    Drafting Information

The principal author of this revenue ruling is Matthew Lay of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Mr. Lay at 202-622-3050 (not a toll-free call).


Text of Revenue Ruling 99-6

Section 708. – Continuation of Partnership

26 CFR 1.708-1: Continuation of partnership.

(Also §§ 731, 732, 735, 741, 751, 1012; 1.741-1; 301.7701-2, 301.7701-3.)

    Issue

What are the federal income tax consequences if one person purchases all of the ownership interests in a domestic limited liability company (LLC) that is classified as a partnership under § 301.7701-3 of the Procedure and Administration Regulations, causing the LLC's status as a partnership to terminate under § 708(b)(1)(A) of the Internal Revenue Code?

    Facts

In each of the following situations, an LLC is formed and operates in a state which permits an LLC to have a single owner. Each LLC is classified as a partnership under § 301.7701-3. Neither of the LLCs holds any unrealized receivables or substantially appreciated inventory for purposes of § 751(b). For the sake of simplicity, it is assumed that neither LLC is liable for any indebtedness, nor are the assets of the LLCs subject to any indebtedness.

Situation 1. A and B are equal partners in AB, an LLC. A sells A's entire interest in AB to B for $10,000. After the sale, the business is continued by the LLC, which is owned solely by B.

Situation 2. C and D are equal partners in CD, an LLC. C and D sell their entire interests in CD to E, an unrelated person, in exchange for $10,000 each. After the sale, the business is continued by the LLC, which is owned solely by E. After the sale, in both situations, no entity classification election is made under § 301.7701-3(c) to treat the LLC as an association for federal tax purposes.

    Law

Section 708(b)(1)(A) and § 1.708-1(b)(1) of the Income Tax Regulations provide that a partnership shall terminate when the operations of the partnership are discontinued and no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership. Section 731(a)(1) provides that, in the case of a distribution by a partnership to a partner, gain is not recognized to the partner except to the extent that any money distributed exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution.

Section 731(a)(2) provides that, in the case of a distribution by a partnership in liquidation of a partner's interest in a partnership where no property other than money, unrealized receivables (as defined in § 751(c)), and inventory (as defined in § 751(d)(2)) is distributed to the partner, loss is recognized to the extent of the excess of the adjusted basis of the partner's interest in the partnership over the sum of (A) any money distributed, and (B) the basis to the distributee, as determined under § 732, of any unrealized receivables and inventory.

Section 732(b) provides that the basis of property (other than money) distributed by a partnership to a partner in liquidation of the partner's interest shall be an amount equal to the adjusted basis of the partner's interest in the partnership, reduced by any money distributed in the same transaction.

Section 735(b) provides that, in determining the period for which a partner has held property received in a distribution from a partnership (other than for purposes of § 735(a)(2)), there shall be included the holding period of the partnership, as determined under § 1223, with respect to the property.

Section 741 provides that gain or loss resulting from the sale or exchange of an interest in a partnership shall be recognized by the transferor partner, and that the gain or loss shall be considered as gain or loss from a capital asset, except as provided in § 751 (relating to unrealized receivables and inventory items).

Section 1.741-1(b) provides that § 741 applies to the transferor partner in a two-person partnership when one partner sells a partnership interest to the other partner, and to all the members of a partnership when they sell their interests to one or more persons outside the partnership.

Section 301.7701-2(c)(1) provides that, for federal tax purposes, the term "partnership" means a business entity (as the term is defined in § 301.7701-2(a)) that is not a corporation and that has at least two members.

In Edwin E. McCauslen v. Commissioner, 45 T.C. 588 (1966), one partner in an equal, two-person partnership died, and his partnership interest was purchased from his estate by the remaining partner. The purchase caused a termination of the partnership under § 708(b)(1)(A). The Tax Court held that the surviving partner did not purchase the deceased partner's interest in the partnership, but that the surviving partner purchased the partnership assets attributable to the interest. As a result, the surviving partner was not permitted to succeed to the partnership's holding period with respect to these assets.

Rev. Rul. 67-65, 1967-1 C.B. 168, also considered the purchase of a deceased partner's interest by the other partner in a two-person partnership. The Service ruled that, for the purpose of determining the purchaser's holding period in the assets attributable to the deceased partner's interest, the purchaser should treat the transaction as a purchase of the assets attributable to the interest. Accordingly, the purchaser was not permitted to succeed to the partnership's holding period with respect to these assets. See also Rev. Rul. 55-68, 1955-1 C.B. 372.

    Analysis and Holdings

Situation 1. The AB partnership terminates under § 708(b)(1)(A) when B purchases A's entire interest in AB. Accordingly, A must treat the transaction as the sale of a partnership interest. Reg. § 1.741-1(b). A must report gain or loss, if any, resulting from the sale of A's partnership interest in accordance with § 741.

Under the analysis of McCauslen and Rev. Rul. 67-65, for purposes of determining the tax treatment of B, the AB partnership is deemed to make a liquidating distribution of all of its assets to A and B, and following this distribution, B is treated as acquiring the assets deemed to have been distributed to A in liquidation of A's partnership interest.

B's basis in the assets attributable to A's one-half interest in the partnership is $10,000, the purchase price for A's partnership interest. Section 1012. Section 735(b) does not apply with respect to the assets B is deemed to have purchased from A. Therefore, B's holding period for these assets begins on the day immediately following the date of the sale. See Rev. Rul. 66-7, 1966-1 C.B. 188, which provides that the holding period of an asset is computed by excluding the date on which the asset is acquired.

Upon the termination of AB, B is considered to receive a distribution of those assets attributable to B's former interest in AB. B must recognize gain or loss, if any, on the deemed distribution of the assets to the extent required by § 731(a). B's basis in the assets received in the deemed liquidation of B's partnership interest is determined under § 732(b). Under § 735(b), B's holding period for the assets attributable to B's one-half interest in AB includes the partnership's holding period for such assets (except for purposes of § 735(a)(2)).

Situation 2. The CD partnership terminates under § 708(b)(1)(A) when E purchases the entire interests of C and D in CD. C and D must report gain or loss, if any, resulting from the sale of their partnership interests in accordance with § 741.

For purposes of classifying the acquisition by E, the CD partnership is deemed to make a liquidating distribution of its assets to C and D. Immediately following this distribution, E is deemed to acquire, by purchase, all of the former partnership's assets. Compare Rev. Rul. 84-111, 1984-2 C.B. 88 (Situation 3), which determines the tax consequences to a corporate transferee of all interests in a partnership in a manner consistent with McCauslen, and holds that the transferee's basis in the assets received equals the basis of the partnership interests, allocated among the assets in accordance with § 732(c).

E's basis in the assets is $20,000 under § 1012. E's holding period for the assets begins on the day immediately following the date of sale.

    Drafting Information

The principal author of this revenue ruling is Matthew Lay of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Mr. Lay at (202) 622-3050 (not a toll-free call).


Text of Notice 99-6

Payment of Employment Taxes with Respect to Disregarded Entities

    Purpose

This notice solicits comments from taxpayers and practitioners regarding issues related to employment tax reporting and payment by qualified subchapter S subsidiaries and other entities that are disregarded as entities separate from their owners for federal tax purposes. This notice also discusses two methods of employment tax compliance that will be accepted by the Service until such time as formal reporting procedures are provided in other guidance. Since the recent enactment of legislation and promulgation of regulations providing that certain wholly owned entities will be disregarded as entities separate from their owners, the Service has received many questions from taxpayers concerning the treatment of disregarded entities for federal employment tax purposes. To help employers comply with the employment tax requirements, the Department of the Treasury and the Internal Revenue Service intend to issue guidance illustrating the proper method for reporting employment taxes with respect to these entities.

    Background

Under § 1361 of the Internal Revenue Code (as amended by § 1308 of the Small Business Job Protection Act of 1996, Pub. L. No. 104-188, 110 Stat. 1755 and § 1601 of the Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 788), an S corporation may own a qualified subchapter S subsidiary. Section 1361(b)(3)(B) defines the term "qualified subchapter S subsidiary" (QSub) as a domestic corporation that is not an ineligible corporation (as defined in § 1361(b)(2)), if (1) an S corporation holds 100 percent of the stock of the corporation, and (2) that S corporation elects to treat the subsidiary as a QSub. Except as otherwise provided in regulations, a corporation for which a QSub election is made is not treated as a separate corporation for federal tax purposes, and all assets, liabilities, and items of income, deduction, and credit of the QSub are treated as assets, liabilities, and items of income, deduction, and credit of the parent S corporation. Similar rules apply to qualified REIT subsidiaries under § 856(i).

Regulations issued under § 7701 of the Code provide for another type of disregarded entity. Section 301.7701-2(c)(2) of the Procedure and Administration Regulations provides that a business entity that has a single owner and that is not a corporation under § 301.7701-2(b) is disregarded as an entity separate from its owner for all federal tax purposes.

In general, employment tax responsibilities rest with an employer. For federal employment tax purposes, the common law rules for determining the identity of the employer ordinarily apply. Under these rules, the person for whom services are performed as an employee is generally considered the employer for purposes of the employment tax provisions. An employer generally is required to withhold and pay over applicable taxes from employees' wages, pay employer taxes, make timely tax deposits, file employment tax returns, and issue wage statements to employees (collectively, "employment tax obligations").

    Request for Comments

Section 1361(b)(3) and § 301.7701-2(c)(2) cause the owner of a disregarded entity to be treated as the employer of the disregarded entity's employees for federal employment tax purposes. Thus, the owner generally is responsible for complying with all the employment tax obligations related to those employees.

Since enactment of the QSub statute and promulgation of the disregarded entity provision of the regulations, however, many taxpayers have mistakenly interpreted § 1361(b)(3) and § 301.7701-2(c)(2) as applying only for federal income tax purposes. In addition, the Service has received numerous comments and questions from other taxpayers that have properly interpreted the statute concerning the difficulties that arise from application of these provisions. Some of these taxpayers have expressed a strong preference for the continued recognition for employment tax purposes of the separate state law entities.

Other taxpayers have expressed a preference for a literal application of the provisions, resulting in the treatment of the owner of the disregarded entity as the employer. Prior to issuing formal guidance, the Service is requesting comments concerning employment tax and certain reporting issues relating to disregarded entities that should be addressed in future guidance. This notice solicits comments from taxpayers and practitioners regarding the following issues:

  1. Any increase or decrease in the administrative burden on taxpayers created by a system of filing employment tax returns under the owner's name and taxpayer identification number where employees are actually employed by a state law entity that is disregarded as an entity separate from its owner for federal tax purposes;

  2. Whether different rules should apply to newly formed disregarded entities with no previous employment tax history as opposed to entities in existence prior to the time when they became disregarded;

  3. Different results (both in amount of tax, type of tax, and time and method of deposits) that arise from filing as one employer as compared to filing as separate employers;

  4. Appropriate methods for notifying the service center about changes in employment tax obligations when an entity's status as a disregarded entity changes;

  5. Possible issues arising in situations where the owner or the disregarded entity is formed or domiciled in a country other than the United States;

  6. Additional issues relating to employment taxes and disregarded entities including, but not limited to, confusion for employees, employers, and state and federal agencies resulting from a single entity reporting structure for employment tax purposes; and

  7. Whether any guidance issued should also apply to qualified REIT subsidiaries (as defined in § 856(i)).

Comments are also requested concerning issues related to disregarded entities but outside the employment tax area. Those issues include but are not limited to the following:

  1. Information reporting on IRS Form 1099s issued by, or with respect to, disregarded entities and their owners; and

  2. Issues related to qualified or nonqualified deferred compensation plans, fringe benefit and welfare plans, and other compensation arrangements.

Written comments should be sent to the following address:

    Internal Revenue Service
    CC:DOM:CORP (NT 99-6; CC:DOM:P&SI:1)
    P.O. Box 7604, Ben Franklin Station
    Washington, DC 20044

In the alternative, comments may be hand delivered between the hours of 8:00 a.m. and 5:00 p.m. to the courier's desk at 1111 Constitution Avenue, NW., Washington, DC, or submitted electronically via the IRS Internet site at http://www.irs.ustreas.gov/prod/tax_regs/comments.html.

Because the Service and Treasury would like to receive comments early in the developmental stages of potential guidance, comments should be forwarded to one of the addresses above prior to April 20, 1999. However, to the extent possible, consideration will be given to comments received after that date.

    Temporary Employment Tax Procedures

Until additional guidance is issued, the Service generally will accept reporting and payment of employment taxes with respect to the employees of a QSub or an entity disregarded as an entity separate from its owner under § 301.7701-2(c)(2) if made in one of two ways:

  1. Calculation, reporting, and payment of all employment tax obligations with respect to employees of a disregarded entity by its owner (as though the employees of the disregarded entity are employed directly by the owner) and under the owner's name and taxpayer identification number; or

  2. Separate calculation, reporting, and payment of all employment tax obligations by each state law entity with respect to its employees under its own name and taxpayer identification number.

If the second method is chosen, the owner retains ultimate responsibility for the employment tax obligations incurred with respect to employees of the disregarded entity. This method merely permits the employment tax obligations of the owner incurred with respect to the disregarded entity to be fulfilled through the separate calculation, reporting, and payment of employment taxes by the disregarded entity. Accordingly, the Service will not proceed against the owner for employment tax obligations relating to employees of a disregarded entity if those obligations are fulfilled by the disregarded entity using its own name and taxpayer identification number, even if there are differences in the timing or amount of payments or deposits as calculated under the second method. If the first method is selected, a final employment tax return should be filed with respect to a disregarded entity that formerly calculated, reported, and paid its employment tax obligations on a separate basis. An owner of multiple disregarded entities may choose the first method with respect to some disregarded entities and the second method with respect to its other disregarded entities. The fact that an owner of a disregarded entity chooses to calculate, report, and pay its employment tax obligations under the second method with respect to a given disregarded entity for one taxable year will not preclude the owner from switching to the first method in a subsequent taxable year. However, if the owner uses the first method of calculating, reporting, and paying employment tax obligations with respect to a given disregarded entity for a return period that begins on or after April 20, 1999, the taxpayer must continue to use the first method unless and until otherwise permitted by the Commissioner.

    Drafting Information

The principal authors of this notice are Deanna Walton of the Office of Assistant Chief Counsel (Passthroughs and Special Industries) and John Richards of the Office of Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information regarding this notice contact Ms. Walton at (202) 622-3050 or Mr. Richards at (202) 622-6040 (not toll-free calls).


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