April 1999 Issue



By Wayne K. Berkowitz, JD, LLM, CPA,
Principal, David Berdon & Co. LLP

The introduction of the single member limited liability company (SMLLC) and the qualified subchapter S subsidiary (QSSS) has created a myriad of Federal and state tax planning opportunities. Generally, for Federal tax purposes, the separate existence of an SMLLC and a QSSS will be ignored, and all of the assets, liabilities, and items of income will be treated as belonging to the member or shareholder. In the wake of this opportunity, many of us have assisted taxpayers in structuring these new types of entities. All of the legal advantages of a separate entity are enjoyed while income and franchise tax liabilities are often optimized by the hypothetical disappearance of the lower-tier entity. Although several states have been slow to follow, virtually all now respect Federal treatment of the SMLLC and QSSS for income and franchise tax purposes.

It first would appear that since the new entity is ignored for both Federal and state income tax purposes, there is no need to worry about the sales tax consequences regarding otherwise taxable transactions between the new entity and its shareholders or members. It would be logical to think the new entity is ignored and such sales are merely a transfer to a division, i.e., a sale has not occurred for purposes of the sales tax.

Although the majority of states have not formally addressed the issue, it seems clear that jurisdictions that have considered the sales tax effect have in large part respected the existence of the second entity for sales tax purposes. As of this writing, only Alabama, Connecticut, Illinois, New York, South Carolina, and Wisconsin have formally addressed the issue.

In Revenue Ruling 98-005 (98 STN 137-1, June 18, 1998), the Alabama Department of Revenue ruled that an SMLLC would be treated as a division of the member corporation for sales tax purposes. In the ruling, the taxpayer inquires whether the sale for resale exemption would apply for transactions between the corporation and the SMLLC. The ruling states that the SMLLC is a "disregarded entity" and must be treated as a branch or division of the corporation. Thus, the sale for resale exemption does not apply. The transfer of inventory from the SMLLC to the corporation for the corporation's use did not constitute a sale for resale but instead constituted a withdrawal from inventory subject to tax under the withdrawal provisions of Alabama Code section 40-23-1(a)(10). The Alabama ruling is interesting as the Department of Revenue chooses to ignore the existence of the separate entity in a situation that will subject the transaction to tax. Generally, this conclusion should prove advantageous to related Alabama taxpayers transferring taxable goods or services or both among themselves.

The Connecticut Department of Revenue Services, in Special Notice SN 98(3) (1998 Conn. Tax LEXIS 3, January 22, 1998), has specifically stated that for both SMLLCs and QSSSs, the separate existence of the entity will be recognized. Therefore, "the sales and use tax laws apply to SMLLCs (and QSSSs) as they would to any other person as that term is defined in Connecticut General Statute section 12-407(l)" [SN 98(3) at Part I.D.]. Although the separate existence of the entity will be ignored for income taxes, the Connecticut sales and use tax will apply to transfers of tangible personal property and enumerated services between the individual, shareholder, or member and the SMLLCs or QSSSs.

The Illinois Department of Revenue, in Private Letter Ruling ST 97-0483-GIL, indirectly addressed the issue in responding to an inquiry regarding whether an SMLLC must file sales and use tax returns separate from its owner. The department responded that "[a]ny limited liability corporation or other entity that is making retail sales subject to the Retailers' Occupation Tax Act or Use Tax Act must be separately registered with its own IBT number and must file returns under that number." Although the department addressed the administrative concern of return filing, the question was not asked or answered regarding otherwise taxable inter-entity goods or services transferred. From the ruling we can assume that the department's position would subject such transfers to the tax, but uncertainty remains.

Although New York has not issued any formal rulings or regulations relating to the sales tax treatment of the SMLLC and the QSSS, the state has made its position clear. In the instructions to form CT-60QSSS, Qualified Subchapter S Subsidiary Information Schedule, the New York State Department of Taxation and Finance has stated that, although it will be ignored for franchise tax purposes, "with regard to other taxes under the Tax Law, such as sales and excise taxes ... the QSSS will continue to be recognized as a separate corporation." No explanation for this position has been set forth.

Similarly, South Carolina, in a detailed Revenue Procedure (SC Revenue Procedure #98-1) explaining the tax treatment of the QSSS for all taxes, mentions almost as an aside the treatment of the QSSS for sales and use tax purposes. The revenue procedure states that "a parent and QSSS are treated as one entity for South Carolina income tax purposes only. A QSSS is treated as a separate corporation for all other state tax purposes, including license fees, sales and use taxes, and property taxes." Although the revenue procedure is more than seven pages long, no additional discussion of this issue
is offered.

Wisconsin had the foresight to partially address the issue by statute. In Wisconsin Statute section 77.58, relating to returns and payments, the statute sets forth that "[i]f a qualified subchapter S subsidiary is not regarded as a separate entity ... the owner of that subsidiary shall include the information for that subsidiary on the owner's return" [Wisconsin Statute section 77.58(3)(a)]. Once again, the only issue directly addressed is the administrative concerns regarding return filings. Is it safe to assume that it is the state's position to ignore the separate existence of the entity since only one return is required?

Uncertainty Remains

The SMLLC and QSSS present a vast array of planning strategies. Nevertheless, uncertainties still exist and will continue to exist for some time regarding the sales and use tax implications of transactions between these entities. States that have formally addressed the issue are few. Those that have addressed the issue fail to do so directly. Uncertainty will likely continue to exist for some time. *

State and Local Editor:
Barry H. Horowitz, CPA
Eisner & Lubin LLP

Interstate Editor:
Nicholas Nessi, CPA
BDO Seidman LLP

Contributing Editors:
Henry Goldwasser, CPA
M.R. Weiser & Co. LLP

Leonard DiMeglio, CPA
PricewaterhouseCoopers LLP

Steven M. Kaplan, CPA
Kahn, Hoffman, Nonenmacher & Hochman, LLP

John J. Fielding, CPA
PricewaterhouseCoopers LLP

Warren Weinstock, CPA
Paneth, Haber & Zimmerman LLP

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