Is an LLC taxed as a partnership a 'portfolio investment partnership,' and is a foreign corporate member subject to Article 9-A by reason of its membership?

Plain-English summary

FGIC CMRC Corp. will be a member of Trinity Funding Company, LLC, an LLC taxed as a partnership federally that sells investment contracts and invests the proceeds in a portfolio of fixed-income securities. FGIC asked (1) whether the LLC is a "portfolio investment partnership" under 20 NYCRR 1-3.2(a)(6)(iii)(d), and (2) whether a foreign corporate member (a non-managing "Preferred Member") is subject to Article 9-A just by being a member.

The Department held:

• New York follows the federal classification. An LLC taxed as a partnership federally is a partnership for New York tax (Tax Law section 208.1; TSB-M-94(6)I/(8)C). So it is consistent to treat an LLC that meets the IRC section 851(b)(2) gross-income requirement and is not a section 1236 dealer in stocks or securities as a portfolio investment partnership.
• A non-managing foreign member is treated like a limited partner. Because a Preferred Member does not participate in management, it stands in the position of a limited partner under 20 NYCRR 1-3.2(a)(6).
  • If the LLC is a portfolio investment partnership, the foreign member is not doing business, employing capital, owning property, or maintaining an office in New York merely by reason of its membership.
  • If the LLC is not a portfolio investment partnership, the member must apply the limited-partner rules of 20 NYCRR 1-3.2(a)(6) -- including the 1%-interest / $1 million-basis thresholds -- to determine whether it is doing business in New York.

This is the foundational LLC-classification / portfolio-investment-partnership opinion that later opinions (e.g., the limited-partner-nexus opinion TSB-A-97(1)C) build on.

What this means for you

New York classifies an LLC the way the IRS does

An LLC taxed as a partnership federally is a partnership in New York; one taxed as a corporation is a corporation. The state does not run a separate classification test.

The portfolio-investment-partnership exception protects passive foreign members

If a partnership (or partnership-LLC) meets the IRC section 851(b)(2) gross-income test and is not a section 1236 securities dealer, it is a portfolio investment partnership, and a foreign corporate limited partner/member is not pulled into New York tax merely by holding its interest.

Otherwise, the limited-partner thresholds apply

If the entity is not a portfolio investment partnership, a foreign corporate member is treated like a limited partner and must apply the 20 NYCRR 1-3.2(a)(6) tests (including the 1% / $1 million thresholds) to decide whether it is doing business in New York.

Common questions

Q: How is an LLC classified for New York tax?
A: It follows the federal classification -- partnership, corporation, or disregarded entity.

Q: What makes an LLC a "portfolio investment partnership"? A: Being taxed as a partnership, meeting the IRC section 851(b)(2) gross-income requirement, and not being a section 1236 dealer in stocks or securities.

Q: Is a foreign member taxable in New York by reason of its membership? A: If the LLC is a portfolio investment partnership, no. If it is not, the member applies the limited-partner doing-business rules (including the 1% / $1 million thresholds).

Citations and references

Statutes, regulations, and authorities:

• Tax Law section 2 (definitions of "limited liability company" and "partnership and partner"); section 208.1 (corporation includes an association, including an LLC)
• 20 NYCRR 1-3.2(a)(6)(i) (foreign corporation that is a limited partner; doing business); 20 NYCRR 1-3.2(a)(6)(iii)(d) (portfolio investment partnership)
• IRC section 851(b)(2) (gross-income requirement); IRC section 1236 (dealer in securities)
• Department Memorandum TSB-M-94(6)I and (8)C; see also limited-partner nexus, TSB-A-97(1)C

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1996.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a96_11c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-96 (11) C
Corporation Tax
April 1, 1996

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C950221A

On February 21, 1995, a Petition for Advisory Opinion was received from FGIC CMRC Corp., 115 Broadway, New York, New York 10006. The issues raised by Petitioner, FGIC CMRC Corp., are (1) whether a limited liability company ("LLC") that is taxable as a partnership for Federal income tax purposes, will be treated as a "portfolio investment partnership" within the meaning of section 1-3.2(a)(6)(iii)(d) of the Business Corporation Franchise Tax Regulations ("Article 9-A Regulations"), and (2) whether a foreign corporation that is a member of an LLC that is taxable as a partnership for Federal income tax purposes, will be subject to tax under Article 9-A of the Tax Law by reason of being a member of the LLC that is doing business, employing capital, owning or leasing property or maintaining an office in New York State. Petitioner submits the following facts as the basis of this Advisory Opinion. Petitioner will be a member of Trinity Funding Company, LLC (the "Company"), an LLC that will be organized pursuant to the New York Limited Liability Company Law. A wholly owned, special purpose subsidiary of JH Holdings, Inc. ("JH Holdings") will serve as managing member of the Company and will be primarily responsible for the management of the Company's affairs. Both Petitioner and the investing subsidiary of JH Holdings will be New York State and New York City taxpayers. Petitioner represents that the Company will be treated as a partnership for Federal income tax purposes. The Company will issue common membership interests ("Common Membership Interests") and preferred membership interests ("Preferred Membership Interests"). The Common Membership Interests will be owned by Petitioner and the investing subsidiary of JH Holdings. The Preferred Membership Interests will be owned by certain foreign corporations (the "Preferred Members").The Preferred Members will not participate in the management of the Company. The Company will sell investment contracts ("Investment Contracts") to third party purchasers ("Investors"). The Investment Contracts will provide a fixed rate of return to the Investors. The Company will invest the proceeds of the Common Membership Interests, the Preferred Membership Interests and the Investment Contracts in a portfolio of fixed-income securities that will pay a return sufficient to allow the Company to satisfy its obligations with respect to the Preferred Membership Interests and the Investment Contracts. Petitioner represents that the Company will satisfy the gross income requirement of section 851(b)(2) of the Internal Revenue Code (the "IRC"). Petitioner further represents that the Company will not be a dealer (within the meaning of section 1236 of the IRC) in stocks or securities.

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TSB-A-96 (11) C
Corporation Tax
April 1, 1996

Section 2 of the Tax Law provides the definition of certain terms used in the Tax Law, and was amended by Chapter 576 of the Laws of 1994 which added the following:

5. The term "limited liability company" means a domestic limited
   liability company ora foreign limited liability company, as defined in section one hundred two of the limited liability company law.
6. "Partnership and partner," unless the context requires otherwise,
   shall include, but shall not be limited to, a limited liability company and a member thereof, respectively. Section 208.1 of the Tax Law provides that the term "corporation" includes an association within the meaning of section 7701(a)(3) of the IRC, including an LLC. Accordingly, an LLC that is treated as a corporation for Federal income tax purposes is treated as a corporation for New York State tax purposes. An LLC that is treated as a partnership for Federal income tax purposes, is treated as a partnership for New York State tax purposes. (See, Department of Taxation and Finance Memorandum, TSB-M-94(6)I and (8)C, October 25, 1994.) Section

1-3.2(a)(6)(i)

of

the

Article

9-A

Regulations

states:

[a] foreign corporation is doing business, employing capital, owning or leasing property or maintaining an office in New York State if it is a limited partner of a partnership, other than a portfolio investment partnership, which is doing business, employing capital, owning or leasing property or maintaining an office in New York State and if it is engaged, directly or indirectly, in the participation in or the domination or control of all or any portion of the business activities or affairs of the partnership .... Section

1-3.2(a)(6)(iii)(d)

of

the

Article

9-A

Regulations

states:

[t]he term "portfolio investment partnership" means a limited partnership which meets the gross income requirement of section 851(b)(2) of the Internal Revenue Code... The term portfolio investment partnership shall not include a dealer (within the meaning of section 1236 of the Internal Revenue Code) in stocks or securities. An LLC that is treated as a partnership for Federal income tax purposes is treated as a partnership for New York State tax purposes. Therefore, it is consistent to treat an LLC that meets the gross income requirement of section 851(b)(2) of the IRC and is not a dealer (within the meaning of section 1236 of the IRC) in stocks or securities as a portfolio investment partnership for purposes of section 1-3.2(a)(6)(iii)(d) of the Article 9-A Regulations.

-3­
TSB-A-96 (11) C
Corporation Tax
April 1, 1996

In this case, a Preferred Member, because it does not participate in the management or operations of the LLC, is substantially in the same position as a limited partner of a limited partnership. Therefore, the treatment provided in section 1-3.2(a)(6) of the Article 9-A Regulations to a foreign corporation that is a limited partner of a partnership should be extended to a foreign Preferred Member. Accordingly, since the Company is treated as a partnership for Federal income tax purposes, it is treated as a partnership for New York State tax purposes. If the Company meets the gross income requirement of section 851(b)(2) of the IRC and the Company is not a dealer, within the meaning of section 1236 of the IRC, in stocks or securities, the Company will be treated as a "portfolio investment partnership" for purposes of section 1-3.2(a)(6)(iii)(d) of the Article 9-A Regulations. Additionally, pursuant to section 1-3.2(a)(6)(i) of the Article 9-A Regulations, if the Company is treated as a portfolio investment partnership, a foreign corporation which is a Preferred Member of the Company is treated as a limited partner and will not be treated as doing business, employing capital, owning or leasing property or maintaining an office in New York State because of its membership in the Company. However, if the Company is not treated as a portfolio investment partnership, a foreign corporation which is a Preferred Member of the Company is treated as a limited partner and the Preferred Member must apply the rules contained in section 1-3.2(a)(6) of the Article 9-A Regulations to determine if it is treated as doing business, employing capital, owning or leasing property or maintaining an office in New York State because of its membership in the Company.

DATED: April 1, 1996

NOTE:

/s/
DORIS S. BAUMAN
Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.