Recent legislation amends the corporate excise statute with respect to the taxation of Limited Liability Companies (LLCs) and certain other entities that are wholly owned by federal S corporations. St. 2003, c.26, § 204. The law affirms the existing policy of the Department of Revenue that LLCs are taxed as corporations if they file federally as corporations. With respect to LLCs that are disregarded as entities separate from their owners under federal tax law ("disregarded entities"), the new law creates two categories with distinct treatments for each. Those disregarded entities that are not owned by S corporations are treated in the same manner as under federal law, that is, they are treated as a branch or division of their owner for Massachusetts purposes and do not file separate returns. Those disregarded entities that are owned by S corporations for federal income tax purposes are taxed themselves under the new statute as S corporations in Massachusetts, even if they are owned by federal S corporations that are taxed as corporate trusts for Massachusetts purposes. The legislation leaves unchanged the rule that LLCs that are currently taxed as partnerships under federal law will be taxed as such under state law. This TIR does not apply to corporate trusts, which are subject to taxation under G.L. c. 62, § 8.
II. Taxation of disregarded entities that are wholly owned by federal S corporations.
A. General Provisions.
1. Disregarded LLCs owned by federal S corporations are taxed separately as S corporations under the corporate excise.
The major change in the recent legislation is that LLCs that are disregarded by their federal S corporation owners are now subject to tax themselves as S corporations under G.L. c. 63, §§ 32, 32D, and 39. G.L. c. 63, §§ 30.1, 30.2, as amended by St. 2003, c. 26, § 204. This legislation is similar to the March 2003 legislation that made qualified subchapter S subsidiaries under IRC § 1361 (QSUBs) subject to taxation as S corporations. See St. 2003, c. 4, § 18.[ 1] The rules in this TIR closely mirror the rules that apply to QSUBs and their S corporation parents, set forth in TIR 03-20. In particular, the LLCs and their federal S corporation parents must separately determine their net income for purposes of G.L. c. 63, §§ 32, 32D, and 39 based solely on their own items of income, loss, deduction, and credit for the taxable year. This technical information release modifies TIR 97-8, "Massachusetts Income Tax Treatment of Limited Liability Companies and Other Unincorporated Business Entities After Federal Adoption of 'Check-the Box' Rules."
2. Taxation of S corporation shareholders in light of the new law.
The new law does not change the taxation of S corporation shareholders on their distributive share income. A Massachusetts S corporation parent's items of income, loss, deduction, and credit, together with those of its subsidiary LLCs, will continue to pass through and be taxable to its shareholders to the extent that such pass-through is required under G.L. c. 62, § 17A and 830 CMR 62.17A.1(5)-(7).
3. Taxation of federal S corporation parents that are not Massachusetts S corporations.
Determining the tax liability of parents of disregarded LLCs that are federal S corporations but are not Massachusetts S corporations (such as corporate trusts, financial institutions, or partnerships) is unaffected by the new legislation. Accordingly, the federal S corporation sole member of an LLC that is disregarded for federal income tax purposes that is not a Massachusetts S corporation will continue to take into account the LLC's income, loss, deduction, and credit in determining its net income subject to tax under G.L. c. 62 or c. 63. See IRC § 1361(b)(3). See also TIR 03-20, §§ VII.C, X.
4. LLC subsidiaries of parent financial institutions that are federal S corporations
An S corporation is taxed as a financial institution if it falls within the definition of financial institution in G.L. c. 63, § 1. TIR 00-6, part IV.B. For purposes of clause (e) of the statutory definition of "financial institution" in § 1, the gross income of the S corporation parent and its disregarded LLC is combined so that if more than 50% of the combined income, excluding non-recurring extraordinary items, is derived from loan origination, lending activities (including discounting obligations), or credit card activities, the S corporation parent and the disregarded LLC will be subject to tax as financial institutions, as described below. See G.L. c. 63, § 1, "Financial institution."
In determining its net income subject to tax under § 2, the parent must take into account its disregarded LLC's income, loss, deduction, and credit. In such a case, as a separate taxpayer, any disregarded LLC that is taxable in Massachusetts must file Form 63FI and pay the minimum excise imposed upon financial institutions under G.L. c. 63, § 2(a).
Since the S corporation parent and its disregarded LLCs are taxed as financial institutions under G.L. c. 63, §§ 1, 2, they are not subject to the non-income measure of the corporate excise imposed under G.L. c. 63, § 32(a)(1) or § 39(a)(1) or the minimum corporate excise under G.L. c. 63, § 32(b) or § 39(b). They are also not subject to tax under c. 63, § 32D.
Conversely, any LLC that is not subject to the financial institution excise under G.L. c. 63, § 2 because its parent is a corporate trust or some other unincorporated entity that falls outside the definition of financial institution, or because the 50% test of G.L. c. 63, § 1, clause (e) is not met, is subject to taxation under G.L. c. 63, § 32D. St. 2003, c.26, § 204.
5. A note on the effective date, and distinctions between the taxation of LLCs and QSUBs.
The new legislation is effective for LLCs for tax years beginning on or after March 5, 2003. St. 2003, c. 26, § 712. There is a major distinction to note between this effective date and that of the legislation that subjected QSUBs to the income measure of the corporate excise. Because LLCs are taxable only for their tax years beginning on or after March 5, 2003, there are no transition rules needed to make year end tax calculations. Since S corporation parents of disregarded LLCs share taxable year beginning and end dates with the disregarded subsidiaries, no transition rules are needed for the parents, either. This contrasts with the taxation of QSUBs, which became subject to the income measure on March 5, 2003, in most cases in the middle of a taxable year, and thus required a series of transition rules. Note also that, unlike QSUBs, disregarded LLCs were not required to file their own returns prior to March 5, 2003, as they were not subject to the non-income measure or the minimum excise.
B. Method for taxing disregarded LLC subsidiaries of S corporations for purposes of the corporate excise.
1. The LLC must aggregate its total receipts with its parent and siblings.
In determining whether, and at what rate, a disregarded LLC with a federal S corporation owner is taxable under G.L. c. 63, § 32D, the LLC must determine its "total receipts" by combining its own receipts with those of its parent S corporation, whether a Massachusetts S corporation, corporate trust, or partnership, and any other related S corporation, QSUB, or entity with which it is engaged in a unitary business. See 830 CMR 62.17A.1(11)(e) and (f).[ 2] This is based on the presumption and subject to the limitations noted in 830 CMR 62.17A.1(11)(f). The aggregated total receipts of all such entities may be adjusted to avoid double counting but must include income taxable at the entity level under G.L. c. 63, § 32D(a)(i). If the combined "total receipts" are at least $6 million but less than $9 million, the income measure of the corporate excise is imposed on the separately determined income of the LLC at the rate of 3%.[ 3] If the combined "total receipts" are $9 million or more, the income measure of the corporate excise is imposed on the separately determined income of the LLC at a rate of 4.5%. In all cases, the disregarded LLC of an S corporation parent must calculate the non-income measure of the excise based on its own assets and liabilities, and pay the greater of the combined income and non-income measures or the minimum excise. G.L. c. 63, §§ 30, 32, 32D, 39. See TIR 97-6.
Similarly, for determining whether, and at what rate, a Massachusetts S corporation parent with one or more disregarded LLC subsidiaries is taxable under G.L. c. 63, § 32D, the Massachusetts S corporation will continue to aggregate its total receipts with those of any related S corporation, LLC, QSUB, or entity with which it is engaged in a unitary business.
Where it is necessary for a disregarded LLC that is taxed under the corporate excise as an S corporation to calculate its apportionment percentage, it must do so based on its own property, payroll, and sales factors. See G.L. c. 63, § 32D(b). In that case, the Massachusetts S corporation parent also must determine its apportionment factors based solely on its own property, payroll, and sales, but only with respect to the tax under G.L. c. 63, § 32D(b). In determining the apportionment percentage that applies to distributive share income of S corporation shareholders, the S corporation will continue to take into account the property, payroll, and sales of the S corporation and its related entities and subsidiaries. 830 CMR 62.17A.1(6).
3. The LLC may be eligible for classification as a manufacturing corporation.
In Directive 00-4, the Department stated that an LLC that is taxed as a corporation can receive manufacturing corporation classification if it otherwise meets the requirements at 830 CMR 58.2.1. DD 00-4, Directive 1. This rule will apply to LLCs with federal S corporation parents that are disregarded for federal purposes but are subject to the entity level corporate excise under the new statute. Directive 2 of DD 00-4, which states that disregarded LLCs can never be manufacturing corporations, is hereby modified.
4. The LLC may be required to submit estimated taxes.
An LLC that can reasonably estimate its corporate excise to be in excess of $1,000 for tax years beginning on or after March 5, 2003, must make estimated tax payments to the Commonwealth, according to the provisions of G.L. c. 63B and 830 CMR 63B.2.2. In determining the underpayment penalty of an LLC subject to the corporate excise by St. 2003, c. 26, § 204, the Department will apply the rule that applies to QSUBs, stated in TIR 03-20, § VIII (A). Specifically, the first of four installment payments due for the first tax year beginning on or after March 5, 2003 is not required. The remaining three installment payments will be required to be paid as follows. The first installment will be due according to rule in 830 CMR 63B.2.2(4)(b)2.b, and should equal 65% of the LLC's required annual payment. The second installment is due according to the rule in 830 CMR 63B.2.2(4)(b)2.c, and should be equal to 25% of the LLC's required annual payment. The third and final installment is due according to the rule in 830 CMR 63B.2.2(4)(b)2.d, and should be equal to 10% of the LLC's required annual payment. No underpayment penalty will be imposed upon any LLC for any installment payment that may become due prior to the issuance of this TIR.
III. Taxation of LLCs that are not disregarded subsidiaries of federal S corporations.
A. LLCs that are taxable as corporations or partnerships.
Single member and multiple member LLCs that are taxed as corporations for federal purposes are also taxed as corporations for state purposes. This rule was announced in TIR 97-8 and continues in force.[ 4] An LLC that is taxed as a partnership for federal purposes is also taxed as a partnership in Massachusetts. G.L. c. 62, § 17.
B. LLCs that are disregarded entities that do not have federal S corporation members.
An LLC that is a disregarded entity and has as its sole member a domestic or foreign corporation that is not a federal S corporation is not separately taxed under the corporate excise provisions. Rather, it is treated as a branch or division of its corporate member, as it is under federal law. G.L. c. 63, §§ 30.1, 30.2, as amended by St. 2003, c. 26, § 204. This is consistent with the rule announced in TIR 97-8.
The recent legislation clarifies existing rules and states new rules with respect to the taxation of LLCs. Any single member or multiple member LLC that is taxed as a corporation federally is also taxed as a corporation for state purposes. The legislation preserves the current rule that any LLC that is taxed as a partnership federally is also taxed as a partnership for state purposes. The major effect of this legislation is to subject disregarded LLCs with federal S corporation parents to the income and non-income measure of the excise as S corporations. This is similar to other recent legislation that has subjected QSUBs to the income measure of the excise in addition to the non-income measure.
Commissioner of Revenue
February 25, 2004
1. The March legislation substantially changed the taxation of QSUBs, making them in many cases subject to the income measure of the corporate excise under G.L. c. 63, § 32D in addition to the non-income measure they were already required to report. St. 2003, c. 4, § 18. See, e.g., G.L. c. 63, §§ 32(a)(2), 39(a)(2).[ return to text]
2. Similarly, in determining whether and at what rate the parent S corporation is taxable, it must determine its "total receipts" by combining its own receipts with those of its related S corporations, QSUBs, or entities with which it is engaged in a unitary business. See 830 CMR 62.17A.1(11)(e) and (f). See TIR 03-20, Example 1. [ return to text]
3. The legislation taxes the LLCs disregarded from S corporation owners in the same manner as S corporations; thus LLCs are subject to all parts of taxation under G.L. c. 63, §§ 32(a)(2), 32D, and 39(a)(2) including taxes on certain built-in gains and passive investment income in IRC §§ 1374 and 1375. [ return to text]
4. The new legislation does not change current practice except to the extent it recognizes a recent statutory change that permits the formation of single member LLCs in Massachusetts. See G.L. 156C, § 2, as amended by St. 2003, c. 4, § 33. Under prior law, only multiple member LLCs could be formed under Massachusetts law, although single member LLCs formed in other states were recognized. G.L. c. 156C, 2000 Official Edition (amended by St. 2003, c. 4, §§ 33 - 45). [ return to text]
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