Disregarded Entities, written by Howard E. Abrams, Esq., of Emory University School of Law, Fred T. Witt, Esq., of Deloitte & Touche LLP, and Lisa M. Zarlenga, Esq., of Steptoe & Johnson LLP, discusses entities that are recognized as having a legal status separate from their owners for certain purposes but are ignored for federal income tax purposes. They include entities disregarded under the elective classification regime, qualified S corporation subsidiaries, and qualified real estate investment trust subsidiaries.  

How can an entire Portfolio be devoted to the tax implications of disregarded entities when such entities are, by definition, disregarded for all federal income tax purposes? The answer is that such entities are not disregarded for non-tax purposes and so can affect the rights and obligations of taxpayers owning and dealing with such entities. Furthermore, it has long been the case that tax consequences are dependent on the rights and obligations of taxpayers as those rights and obligations are defined by non-tax rules and regulations. Accordingly, the creation, use, or liquidation of an entity disregarded for tax purposes has an indirect (and “indirect” should not suggest insignificant) effect on the taxpayers whose non-tax relationships are affected by the entity. Finally, a number of important exceptions to disregarded status have emerged in the federal tax laws in recent years. 

This Portfolio addresses the use of disregarded entities in specific contexts—including corporate reorganizations, partnership transactions, and like-kind exchanges—along with type of entity, qualification, formation, conversion, operation, and termination issues.  

In addition, the Portfolio discusses the application of specific provisions such as the at-risk rules and the cancellation of indebtedness provisions, and it describes the use of disregarded entities in cross-border transactions and their impact on the direct and indirect foreign tax credit. 

The Worksheets provide a list of key tax forms and primary source documents as well as preambles to relevant treasury regulations. 

Disregarded Entities allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents including tables, charts and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
• Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.

Detailed Analysis

I. Introduction

Introductory Material

A. The Definition of a Disregarded Entity

1. The Three Formally Disregarded Entities

2. The Peculiar Status of Grantor Trusts

B. Recognition of an Otherwise-Disregarded Entity

1. Tax Obligations

2. Assessment and Collection Issues

3. TEFRA Unified Audit Procedures

II. Formation and Classification of a “Check-the-Box” Disregarded Entity

A. History of Entity Classification

B. Initial Classification

1. “Business Entity” Versus Trust

2. Single Owner

3. Per Se Corporations

4. “Eligible Entities”

5. Default Classification

6. Elective Classification

7. Entities Owned by Husband and Wife

8. Nominal Owners Ignored

9. Foreign Entities

C. Change in Classification

1. Elective Classification Change

a. Sixty-Month Limitation on Subsequent Election

b. Timing of the Classification Change

c. Need for a Business Purpose?

d. Tax Consequences of the Election

(1) From Association Taxable as a Corporation to Disregarded Entity

(2) From Disregarded Entity to Association Taxable as a Corporation

2. Changes in Ownership Structure (Automatic Changes)

a. From Disregarded Entity to Partnership

b. From Partnership to Disregarded Entity

(1) Contribution of Interests from Partners to Corporation

(2) Contribution of Interests from Partners to a Partnership

(3) Sale of Interests

(4) Special Problems in the Context of Consolidated Groups

c. From Disregarded Entity to Per Se Corporation

3. Rescission of Conversion

III. Use of Disregarded Entities

A. Disregarded Entities and Specific Code Provisions

1. Section 108 - Discharge of Indebtedness Income

2. Section 170 - Charitable Contributions

3. Section 465 - At-Risk Rules

4. Section 1001 - Recognition of Gain or Loss

a. Transfer of Disregarded Entity Assets Subject to Debt

b. Modification of Indebtedness

5. Section 1031 - Like-Kind Exchanges

a. Transfer of Asset for Asset

b. Transfer of Interest in Entity for Asset

c. Transfer of Asset for Interest in Entity

d. Transfer of Interest in Entity for Interest in Entity

B. Disregarded Entities and Partnerships

1. Disregarded Entities as Partners

a. Owning a General Partnership Interest Through a Disregarded Entity

(1) Allocations of Partnership Tax Items

(2) Allocations of Partnership Liabilities

b. Guarantee of the Disregarded Entity's Obligations to the Partnership

2. Disregarded Entities Held by Partnerships

C. Disregarded Entities and Corporations

1. Use of Disregarded Entities to Avoid Taxation on Distributions

2. Use of Disregarded Entities in Mergers and Consolidations

a. Disregarded Entities and Continuity of Business Enterprise

b. “A” Reorganizations

(1) In General

(2) Foreign Mergers

(3) Conversions and Check-the-Box Elections as Mergers

c. “B” Reorganizations

d. “C” Reorganizations

e. Acquisitive “D” Reorganizations

f. Subsidiary Acquisitive Reorganizations

(1) Use of Grandparent Stock

(2) Using a Disregarded Entity to Avoid Reverse-Triangular Restrictions

3. Divisive Reorganizations and Related Transactions

a. Using a Merger to Effect a Division

b. Using Disregarded Entities to Satisfy the Active Trade or Business Requirement

c. Distributing Interests in a Disregarded Entity as a Split-Up

d. Replacing a Divisive Distribution with a Liquidation

4. “F” Reorganizations

a. Reincorporation by Elective Classification Conversion

b. Segregating Assets and Liabilities

5. Use of Disregarded Entities in Consolidated Groups

a. Selective Consolidation and Deconsolidation

b. Eliminate an Excess Loss Account

c. Avoiding SRLY Limitation

D. Disregarded Entities Used in Cross-Border Transactions

1. An Overview of the Taxation of Foreign Business Activity by U.S. Taxpayers

a. In General

b. Branch Transactions Under Section 987

2. Reporting Requirements

3. Use of Hybrids and Reverse Hybrids

a. Using Foreign Disregarded Entities to Reduce Foreign Taxes

b. The Direct and Indirect Foreign Tax Credits

c. Effects on Financing Transactions

(1) Foreign Subsidiary Lender

(2) Foreign Subsidiary Borrower

(3) Domestic Subsidiary Borrower

(4) Apportionment Computations

d. Subpart F Planning

(1) Check and Sell to Avoid Foreign Personal Holding Company Income

(2) Full Inclusion Rule

(3) High Tax Exception

e. Intercompany Transfers

(1) Transfers to Controlled Corporations

(2) Sales by Foreign Subsidiary to U.S. Parent

(3) Sales by U.S. Parent to Foreign Subsidiary

E. State and Local Taxes

1. Sales and Use Taxes

2. State Income Taxes

IV. Qualified Subchapter S Subsidiaries

A. S Corporations Generally

1. Qualification and Election

2. One Class of Stock

3. Formation

4. Pass-Through of Corporate Income and Deduction

5. Shareholder Debt and Equity Basis

6. Nonliquidating Distributions

7. Dispositions of Shares and Liquidating Distributions

a. Disposition of Stock Not in Redemption

b. Redemptions of Stock

c. Liquidating Distributions

8. Transition Issues

a. From C Corporation to S Corporation

(1) Shareholder Taxation of Distributions

(2) Corporate-Level Tax on Built-In Gains

(3) Recapture of LIFO Benefits

(4) Disabilities Associated with Passive Income

(5) No Carryover from C Year to S Year

b. From S Corporation to C Corporation

B. Qualified Subchapter S Subsidiaries (QSubs)

1. Qualification, Election and Termination

a. Timing of the Election

b. Tax Consequences of the Election

(1) Built-In Gains Tax of the Parent

(2) Carryover of Tax Attributes

c. Termination of the Election

(1) Termination by Revocation

(2) Termination by Parent Losing S Corporation Status

(3) Termination by QSub Losing its Eligibility

(4) Termination by Transfer of QSub Stock

2. Taxation

3. Planning Opportunities

4. A Comparison of Q-Subs and Single-Member LLCs

a. Formation of a Newly Created Entity

b. Operation of the Entity

c. Termination of the Entity

(1) Transfer of Assets and Liquidation of the Entity

(2) Conversion into a Regarded Subsidiary

(3) Introduction of Additional Owners

(4) Transfer of the Entity

V. Qualified Real Estate Investment Trust Subsidiaries

A. Real Estate Investment Trusts Generally

1. Qualification and Election

2. Termination

3. Taxation

4. Taxable REIT Subsidiaries

B. Qualified Real Estate Investment Trust Subsidiaries

1. Creation and Qualification

2. Termination

a. Conversion to a Taxable REIT Subsidiary

b. Addition of a Second Equity Owner

c. Termination of Parent's REIT Status

d. Transfer to Another REIT

3. Taxation of the QREITSub

4. Recognition of the QREITSub as a Separate Corporation for Limited Administrative Purposes

Working Papers

Table of Worksheets

Worksheet 1 List of Key Tax Forms and Primary Source Documents

Worksheet 2 Preamble to 1997 Changes to Regulations Under 7701

Worksheet 3 Preamble to 1999 Changes to Regulations Under 7701

Worksheet 4 Preamble to 1998 Changes to Regulations Under 368

Worksheet 5 Preamble to 2003 Temporary Regulations Under 368

Worksheet 6 Preamble to Final Regulations Under 752

Worksheet 7 Preamble to Final Regulations Under 368

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Treasury Rulings:

Cases:

UNOFFICIAL

Books and Treatises

Periodicals

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