[Federal Register Volume 61, Number 244 (Wednesday, December 18, 1996)]
[Rules and Regulations]
[Pages 66584-66593]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-31997]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 8697]
RIN 1545-AT91


Simplification of Entity Classification Rules

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that classify certain 
business organizations under an elective regime. These regulations 
replace the existing classification rules.

DATES: These regulations are effective as of January 1, 1997.
    For dates of applicability of these regulations, see Effective 
Dates under Supplementary Information.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Mark D. 
Harris, (202) 622-3050; concerning foreign organizations, William H. 
Morris or Ronald M. Gootzeit, (202) 622-3880 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1486. Responses to these collections of information 
are required to obtain a benefit (to choose an entity's classification 
by election).
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    The estimates of the reporting burden in these final regulations 
are reflected in the burden estimates in Form 8832 (Entity 
Classification Election).
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, 
DC 20224, and to the Office of Management and Budget, Attn: Desk 
Officer for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503.
    Books or records relating to these collections of information must 
be retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On April 3, 1995, Notice 95-14 (1995-1 C.B. 297), relating to 
classification of business organizations under section 7701 of the 
Code, was published in the Internal Revenue Bulletin. A notice of 
public hearing was published in the Federal Register on May 10, 1995 
(60 FR 24813). Written comments were received and a public hearing was 
held on July 20, 1995.
    On May 13, 1996, the IRS and Treasury issued a notice of proposed 
rulemaking (61 FR 21989 [PS-43-95, 1996-24 I.R.B. 20]) under section 
7701. The regulations proposed to replace the existing regulations for 
classifying certain business organizations with an elective regime. 
Comments responding to the notice were received, and a public hearing 
was held on August 21, 1996. After considering the comments that were 
received in response to the notice of proposed rulemaking and the 
statements made at the public hearing, the proposed regulations are 
adopted as revised by this Treasury decision. The revisions are 
discussed below.

Explanation of Provisions

    Section 7701(a)(2) of the Code defines a partnership to include a 
syndicate, group, pool, joint venture, or other unincorporated 
organization, through or by means of which any business, financial 
operation, or venture is carried on, and that is not a trust or estate 
or a corporation. Section 7701(a)(3) defines a corporation to include 
associations, joint-stock companies, and insurance companies.
    The existing regulations for classifying business organizations as 
associations (which are taxable as corporations under section 
7701(a)(3)) or as partnerships under section 7701(a)(2) are based on 
the historical differences under local law between partnerships and 
corporations. Treasury and the IRS believe that those rules have become 
increasingly formalistic. This document replaces those rules with a 
much simpler approach that generally is elective.

[[Page 66585]]

    As stated in the preamble to the proposed regulations, in light of 
the increased flexibility under an elective regime for the creation of 
organizations classified as partnerships, Treasury and the IRS will 
continue to monitor carefully the uses of partnerships in the 
international context and will take appropriate action when 
partnerships are used to achieve results that are inconsistent with the 
policies and rules of particular Code provisions or of U.S. tax 
treaties.

A. Summary of the Regulations

    Section 301.7701-1 provides an overview of the rules applicable in 
determining an organization's classification for federal tax purposes. 
The first step in the classification process is to determine whether 
there is a separate entity for federal tax purposes. The regulations 
explain that certain joint undertakings that are not entities under 
local law may nonetheless constitute separate entities for federal tax 
purposes; however, not all entities formed under local law are 
recognized as separate entities for federal tax purposes. Whether an 
organization is treated as an entity for federal tax purposes is a 
matter of federal tax law, and does not affect the rights and 
obligations of its owners under local law. For example, if a domestic 
limited liability company with a single individual owner is disregarded 
as an entity separate from its owner under Sec. 301.7701-3, its 
individual owner is subject to federal income tax as if the company's 
business was operated as a sole proprietorship.
    An organization that is recognized as a separate entity for federal 
tax purposes is either a trust or a business entity (unless a provision 
of the Code expressly provides for special treatment, such as the 
Qualified Settlement Fund rules (Sec. 1.468B) or the Real Estate 
Mortgage Investment Conduit (REMIC) rules, see section 860A(a)). The 
regulations provide that trusts generally do not have associates or an 
objective to carry on business for profit. The distinctions between 
trusts and business entities, although restated, are not changed by 
these regulations.
    Section 301.7701-2 clarifies that business entities that are 
classified as corporations for federal tax purposes include 
corporations denominated as such under applicable law, as well as 
associations, joint-stock companies, insurance companies, organizations 
that conduct certain banking activities, organizations wholly owned by 
a State, organizations that are taxable as corporations under a 
provision of the Code other than section 7701(a)(3), and certain 
organizations formed under the laws of a foreign jurisdiction 
(including a U.S. possession, territory, or commonwealth).
    The regulations in Sec. 301.7701-2 include a special grandfather 
rule, under which an entity described in the list of foreign entities 
treated as per se corporations will nevertheless be classified as other 
than a corporation. The regulations also list certain situations where 
a grandfathered entity would lose its grandfathered status.
    Any business entity that is not required to be treated as a 
corporation for federal tax purposes (referred to in the regulation as 
an eligible entity) may choose its classification under the rules of 
Sec. 301.7701-3. Those rules provide that an eligible entity with at 
least two members can be classified as either a partnership or an 
association, and that an eligible entity with a single member can be 
classified as an association or can be disregarded as an entity 
separate from its owner. However, if the single owner of a business 
entity is a bank (as defined in section 581), then the special rules 
applicable to banks will continue to apply to the single owner as if 
the wholly owned entity were a separate entity.
    In order to provide most eligible entities with the classification 
they would choose without requiring them to file an election, the 
regulations provide default classification rules that aim to match 
taxpayers' expectations (and thus reduce the number of elections that 
will be needed). The regulations adopt a passthrough default for 
domestic entities, under which a newly formed eligible entity will be 
classified as a partnership if it has at least two members, or will be 
disregarded as an entity separate from its owner if it has a single 
owner. The default for foreign entities is based on whether the members 
have limited liability. Thus a foreign eligible entity will be 
classified as an association if all members have limited liability. A 
foreign eligible entity will be classified as a partnership if it has 
two or more members and at least one member does not have limited 
liability; the entity will be disregarded as an entity separate from 
its owner if it has a single owner and that owner does not have limited 
liability. Finally, the default classification for an existing entity 
is the classification that the entity claimed immediately prior to the 
effective date of these regulations. An entity's default classification 
continues until the entity elects to change its classification by means 
of an affirmative election.
    An eligible entity may affirmatively elect its classification on 
Form 8832, Entity Classification Election. The regulations require that 
the election be signed by each member of the entity or any officer, 
manager, or member of the entity who is authorized to make the election 
and who represents to having such authorization under penalties of 
perjury. An election will not be accepted unless it includes all of the 
required information, including the entity's taxpayer identifying 
number (TIN).
    Taxpayers are reminded that a change in classification, no matter 
how achieved, will have certain tax consequences that must be reported. 
For example, if an organization classified as an association elects to 
be classified as a partnership, the organization and its owners must 
recognize gain, if any, under the rules applicable to liquidations of 
corporations.

B. Discussion of Comments on the General Approach and Scope of the 
Regulations

    Several comments requested clarification with regard to the rules 
for determining when an owner of an interest in an organization will be 
respected as a bona fide owner for federal tax purposes. Some 
commentators were concerned, for example, that certain owners would be 
required to maintain certain net worth requirements. Other 
commentators, relying on Rev. Rul. 93-4, 1993-1 C.B. 225, suggested 
that if two wholly-owned subsidiaries of a common parent were the 
owners of an organization, those owners would not be respected as bona 
fide owners and the organization would be treated as having only one 
owner (the common parent). Although the determination of whether an 
organization has more than one owner is based on all the facts and 
circumstances, the fact that some or all of the owners of an 
organization are under common control does not require the common 
parent to be treated as the sole owner. Consistent with this approach, 
Rev. Rul. 93-4 treated two wholly owned subsidiaries as associates and 
then classified the foreign entity based on the four corporate 
characteristics under section 7701. While these four factors will no 
longer apply with the adoption of the regulations, determining whether 
the subsidiaries are associates continues to be an issue.
    The IRS has received a number of comments asking for clarification 
of the tax treatment of entities that are wholly owned by an Indian 
tribe and incorporated under tribal law. Treasury and the IRS are 
currently studying this

[[Page 66586]]

issue and will, if necessary, issue separate guidance regarding this 
issue.
    Most commentators agreed that inclusion of the list of foreign 
business entities treated as corporations per se was appropriate. 
However, several commentators requested clarification about certain 
foreign business entities on the per se list. Other commentators 
requested clarification whether and how the list of such corporations 
might be updated in the future. The regulations are clarified with 
respect to entities formed in the following jurisdictions: Aruba, 
Canada, People's Republic of China, Republic of China (Taiwan), India, 
Indonesia, Netherlands Antilles, and Sweden. Any further modifications 
will be announced in a notice of proposed rulemaking and will be 
prospective only.
    Commentators also raised the issue of how to determine if a joint 
venture or other contractual arrangement that is considered a separate 
entity under these regulations is considered a foreign or domestic 
entity. This issue is outside the scope of these regulations and thus 
is not addressed in the final regulations.
    Some commentators raised issues relating to the application of the 
grandfather rule for certain existing entities organized under foreign 
statutes included on the list of per se corporations. In particular, 
commentators requested clarification regarding existing entities that 
would be listed on the per se list. Commentators have asked whether an 
existing entity on the per se list which had claimed non-corporate 
status could retain that status, and, if so, whether it could 
subsequently elect to be treated as a corporation. Commentators also 
asked for clarification as to the effect of a deemed termination under 
section 708(b)(1)(B) or a division under section 708(b)(2)(B) on a 
grandfathered per se entity.
    In response to these comments, the grandfather rules clarify that 
an entity on the list which was previously disregarded as a separate 
entity (i.e., treated as a branch) or was treated as a partnership may 
continue to be treated as such when the regulations become effective. 
Moreover, entities on the list which continue to treat themselves as 
branches or partnerships after the effective date of the regulations 
may subsequently elect to be treated as corporations. However, after 
such election they may not subsequently elect to be treated as a 
partnership or a branch. Finally, any termination under section 
708(b)(1)(B) (except in the case of a sale or exchange of interests in 
an entity described in Sec. 301.7701-2(d)(2) where the sale or exchange 
is to a related person within the meaning of sections 267(b) and 707(b) 
and occurs no later than 12 months after the date the entity is formed) 
or division under section 708(b)(2)(B) will end the grandfathered 
status of any entity on the per se list, and therefore the successor 
entity (or entities) will thereafter be permanently treated as a 
corporation.
    Other commentators suggested that the requirement that an existing 
entity included on the per se list must have claimed passthrough 
treatment for all prior periods is burdensome and precludes grandfather 
treatment for entities that restructured in the past and recognized the 
resulting tax consequences. In response to these comments, the 
regulations are modified to indicate that an existing entity can 
continue to be treated as a non-corporate entity if it was in existence 
on May 8, 1996, and was reasonably treated as a non-corporate entity on 
that date (or formed thereafter pursuant to a written binding contract 
in effect on May 8, 1996, in which the parties agreed to engage 
(directly or indirectly) in an active and substantial business 
operation in the jurisdiction in which the entity is formed, and which 
would otherwise meet the grandfather rules if the date the entity is 
formed is substituted for May 8, 1996). If the entity changed its 
claimed tax status within the sixty months prior to May 8, 1996, the 
entity and its members must have recognized the tax consequences that 
resulted from that change in tax status. Moreover, the regulations 
clarify that the grandfather treatment applies if no person for whom 
the entity's classification was relevant on May 8, 1996, treats the 
entity as a corporation for purposes of filing such person's federal 
income tax returns, information returns, and withholding documents for 
the period including May 8, 1996.
    One commentator suggested that it was unclear when the 
classification of a foreign entity is ``relevant'' for federal tax 
purposes. This determination is important, as it affects whether the 
grandfather rule, the default rule for existing entities, or the 
default rule for a newly formed foreign entity applies. In general, an 
entity's classification is relevant when its classification affects the 
liability of any person for federal tax or information purposes. The 
date that the classification of a foreign entity is relevant is the 
date an event occurs that causes an obligation to file a return or 
statement for which the classification of the entity must be 
determined.

C. Discussion of Comments Relating to the Elective Regime

    Most of the commentators agreed that the default rules included in 
the proposed regulations generally would match taxpayers' expectations. 
However, some commentators expressed concern over the application of 
the default rule for newly formed foreign eligible entities which would 
treat such entities as associations if no member had unlimited 
liability. Specifically, certain commentators noted that under the 
definition of unlimited liability in the proposed regulations, certain 
contractual joint ventures which, under current law, would generally be 
classified as partnerships, would be treated as associations under the 
default rule. The members of these contractual joint ventures are not 
jointly and severally liable for all debts of the entity; rather, each 
member has unlimited liability for a certain proportion of the debts of 
the entity. To simplify the default rules, the regulations are modified 
to provide that a newly formed foreign eligible entity will--(1) be 
treated as a partnership if it has at least two members and at least 
one member does not have limited liability; (2) be treated as an 
association if all members of the entity have limited liability; and 
(3) be disregarded as an entity separate from its owner if it has a 
single owner that does not have limited liability.
    The regulations are modified to provide that a member does not have 
limited liability if the member, by virtue of being a member, has 
personal liability for all or any portion of the debts of the entity.
    Certain commentators asked for clarification of the default rule in 
the case where the relevant statute or law of a particular country 
provides for limited or unlimited liability. Generally, the regulations 
specify that only the statute or law is relevant. Where, however, the 
underlying statute allows the entity to specify in its organizational 
documents whether the members will have limited liability, the 
organizational documents may be relevant.
    Some commentators requested that taxpayers be allowed to make 
classification elections with their first tax returns. The regulations 
retain the requirement that elections be made at the beginning of the 
taxable year. Treasury and the IRS continue to believe that it is 
appropriate to determine an entity's classification at the time that it 
begins its operations. Taxpayers can specify the date on which an 
election will be effective, provided that date is not more than 75

[[Page 66587]]

days prior to the date on which the election is filed (irrespective of 
when the interest was acquired) and not more than 12 months after the 
date the election was filed. If a taxpayer specifies an effective date 
more than 75 days prior to the date on which the election is filed, the 
election will be effective 75 days prior to the date on which the 
election was filed. If a taxpayer specifies an effective date more than 
12 months from the filing date, the election will be effective 12 
months after the date the election was filed. No election, whenever 
filed, will be effective before January 1, 1997.
    One commentator expressed concern about the ability to make 
protective elections where there is uncertainty, for example, about an 
entity's status as a business entity. Such protective elections are not 
prohibited under the regulations.
    The regulations limit the ability of an entity to make multiple 
classification elections by prohibiting more than one election to 
change an entity's classification during any sixty month period. One 
commentator suggested that the regulations be amended to waive 
application of this rule in certain circumstances, particularly when 
there has been a substantial change in ownership of the entity. In 
response to this comment, the regulations permit the Commissioner to 
waive the application of the sixty month limitation by letter ruling. 
However, waivers will not be granted unless there has been more than a 
fifty percent ownership change. The sixty month limitation only applies 
to a change in classification by election; the limitation does not 
apply if the organization's business is actually transferred to another 
entity.
    Several commentators requested clarification concerning the 
classification of a foreign entity when the classification of the 
entity becomes relevant for federal tax purposes after a period during 
which the classification of the entity was not relevant. Generally, 
such an entity will retain its prior classification. However, if the 
classification of a foreign eligible entity which was previously 
relevant for federal tax purposes ceases to be relevant for sixty 
consecutive months, the entity's classification will be determined 
initially under the default classification when the classification of 
the foreign eligible entity again becomes relevant.
    Some commentators requested clarification regarding the rule 
permitting elections to be signed by any authorized officer, manager, 
or member of the electing entity. The regulations retain this rule, as 
it provides taxpayers with flexibility in complying with the election 
requirements. The determination of whether a person is authorized to 
make an election is based on local law. Thus, the election can be made 
by anyone authorized to act on behalf of the entity.
    Several commentators asked for guidance regarding the necessary 
signatures on the classification election. The regulations are modified 
to provide that if the election is made by all of the members, each 
person who is an owner at the time the election is made must consent to 
the election. However, if an election is to be effective for any period 
prior to the date it is filed, each person who was an owner between the 
date the election is to be effective and the date the election is filed 
(even if by an authorized person), and who is not an owner at the time 
the election is filed, must also consent to the election.
    Several commentators requested that the classification election be 
coordinated with the election under section 856(c)(1) to be a real 
estate investment trust (REIT). Because the latter election is required 
to be made with the REIT's first tax return, the regulations are 
modified to provide that an election by an eligible entity to be a REIT 
will be treated as a deemed election to be classified as an 
association, effective for the entire period during which REIT status 
is claimed.
    Some commentators suggested that the regulations should not require 
an entity or its direct or indirect owners to attach a copy of the 
entity's election to their federal tax returns. Specifically, some 
commentators were concerned that the failure of one owner to attach a 
copy of the election to the owner's return would void an otherwise 
valid election. The regulations retain the requirement that taxpayers 
must attach a copy of the election to their returns, but clarify that 
failure to do so will not invalidate an otherwise valid election. 
Although the failure to attach a copy will not adversely affect an 
otherwise valid election, taxpayers are reminded that each member of 
the entity is required to file returns that are consistent with the 
entity's election. Failure to attach the election form to a federal tax 
or information return as directed in the regulations may give rise to 
penalties against the non-filing party. Other applicable penalties may 
also apply to parties who file federal tax or information returns 
inconsistent with the entity's election.
    One commentator asked for guidance on the treatment of conversions 
by election from partnership to corporation and from corporation to 
partnership. This issue is outside the scope of these classification 
rules and thus is not addressed in these regulations. Treasury and the 
IRS, however, are actively considering issuing guidance on the 
treatment of such conversions.

D. Effective Dates

    The regulations are effective as of January 1, 1997. The 
regulations provide a special transition rule for existing entities. 
The IRS will not challenge the prior classification of an existing 
eligible entity, or an existing entity described on the per se list, 
for periods prior to January 1, 1997, if--(1) the entity had a 
reasonable basis (within the meaning of section 6662) for its claimed 
classification; (2) the entity and all members of the entity recognized 
the federal tax consequences of any change in the entity's 
classification within the sixty months prior to January 1, 1997; and 
(3) neither the entity nor any member had been notified in writing on 
or before May 8, 1996, that the classification of the entity was under 
examination (in which case the entity's classification will be 
determined in the examination).
    Some commentators were concerned that an entity organized after May 
8, 1996, would be excluded from this transition rule for existing 
entities. Because Sec. 301.7701-3(f)(2) applies to entities that were 
in existence prior to January 1, 1997, no change is necessary to 
provide relief for entities organized after May 8, 1996.
    Some commentators were concerned about entities that claimed to be 
trusts for the period prior to January 1, 1997, but are subsequently 
determined to be business entities. In that case, the entity's claimed 
classification for purposes of applying the provisions of the special 
transition rule will be the business entity classification claimed by 
the entity after it has been determined to be a business entity.

Effect on Other Documents

    The Service has published a number of revenue rulings and revenue 
procedures interpreting the section 7701 regulations. The Service is 
currently reviewing these revenue rulings and revenue procedures to 
determine which are affected by the publication of these regulations. 
See accompanying Notice 97-1. Special Analyses
    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5

[[Page 66588]]

U.S.C. chapter 5) does not apply to these regulations. It is hereby 
certified that these regulations do not have a significant economic 
impact on a substantial number of small entities. This certification is 
based upon the fact that the automatic classification rules of 
Sec. 301.7701-2(b) and the default classification rules of 
Sec. 301.7701-3(b) will operate in such a manner that only a limited 
number of entities will need to make an election under Sec. 301.7701-
3(c) to determine their classification. Therefore, a Regulatory 
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) is not required. Pursuant to section 7805(f) of the Internal 
Revenue Code, the notice of proposed rulemaking preceding these final 
regulations has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal authors of these regulations are Armando Gomez and 
Mark D. Harris of the Office of Assistant Chief Counsel (Passthroughs 
and Special Industries) and William H. Morris and Ronald M. Gootzeit of 
the Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1, 301, and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.581-1 is revised to read as follows:


Sec. 1.581-1  Banks.

    (a) In order to be a bank as defined in section 581, an institution 
must be a corporation for federal tax purposes. See Sec. 301.7701-2(b) 
of this chapter for the definition of a corporation.
    (b) This section is effective as of January 1, 1997.
    Par. 3. Section 1.581-2 is amended as follows:
    1. Paragraph (a) is removed.
    2. Paragraphs (b) and (c) are redesignated as paragraphs (a) and 
(b), respectively.
    3. Newly designated paragraph (a) is amended by revising the second 
and last sentences.
    The revisions read as follows:


Sec. 1.581-2  Mutual savings banks, building and loan associations, and 
cooperative banks.

    (a) * * * See section 593 for special rules concerning reserves for 
bad debts. * * * See also section 594 and Sec. 1.594-1 for special 
rules governing the taxation of a mutual savings bank conducting a life 
insurance business.
* * * * *
    Par. 4. In Sec. 1.761-1, paragraph (a) is revised to read as 
follows:


Sec. 1.761-1  Terms defined.

    (a) Partnership. The term partnership means a partnership as 
determined under Secs. 301.7701-1, 301.7701-2, and 301.7701-3 of this 
chapter.
* * * * *

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 5. The authority citation for part 301 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 6. Section 301.6109-1 is amended as follows:
    1. Paragraph (b)(2)(iii) is amended by removing the language 
``and'' at the end of the paragraph.
    2. Paragraph (b)(2)(iv) is amended by removing the period at the 
end of the paragraph, and replacing it with the language ``; and''.
    3. Paragraph (b)(2)(v) is added.
    4. The text of paragraph (d)(2) is redesignated as paragraph 
(d)(2)(i).
    5. A paragraph heading is added for newly designated paragraph 
(d)(2)(i).
    6. Paragraph (d)(2)(ii) is added.
    The revisions and additions read as follows:


Sec. 301.6109-1  Identifying numbers.

* * * * *
    (b) * * *
    (2) * * *
    (v) A foreign person that makes an election under Sec. 301.7701-
3(c).
* * * * *
    (d) * * *
    (2) Employer identification number--(i) In general. * * *
    (ii) Special rule for entities electing to change their federal tax 
classification under Sec. 301.7701-3(c). Any entity that has an 
employer identification number and then elects under Sec. 301.7701-3(c) 
to change its federal tax classification will retain that employer 
identification number.
* * * * *
    Par. 7. Sections 301.7701-1, 301.7701-2, and 301.7701-3 are revised 
to read as follows:


Sec. 301.7701-1  Classification of organizations for federal tax 
purposes.

    (a) Organizations for federal tax purposes--(1) In general. The 
Internal Revenue Code prescribes the classification of various 
organizations for federal tax purposes. Whether an organization is an 
entity separate from its owners for federal tax purposes is a matter of 
federal tax law and does not depend on whether the organization is 
recognized as an entity under local law.
    (2) Certain joint undertakings give rise to entities for federal 
tax purposes. A joint venture or other contractual arrangement may 
create a separate entity for federal tax purposes if the participants 
carry on a trade, business, financial operation, or venture and divide 
the profits therefrom. For example, a separate entity exists for 
federal tax purposes if co- owners of an apartment building lease space 
and in addition provide services to the occupants either directly or 
through an agent. Nevertheless, a joint undertaking merely to share 
expenses does not create a separate entity for federal tax purposes. 
For example, if two or more persons jointly construct a ditch merely to 
drain surface water from their properties, they have not created a 
separate entity for federal tax purposes. Similarly, mere co-ownership 
of property that is maintained, kept in repair, and rented or leased 
does not constitute a separate entity for federal tax purposes. For 
example, if an individual owner, or tenants in common, of farm property 
lease it to a farmer for a cash rental or a share of the crops, they do 
not necessarily create a separate entity for federal tax purposes.
    (3) Certain local law entities not recognized. An entity formed 
under local law is not always recognized as a separate entity for 
federal tax purposes. For example, an organization wholly owned by a 
State is not recognized as a separate entity for federal tax purposes 
if it is an integral part of the State. Similarly, tribes incorporated 
under section 17 of the Indian Reorganization

[[Page 66589]]

Act of 1934, as amended, 25 U.S.C. 477, or under section 3 of the 
Oklahoma Indian Welfare Act, as amended, 25 U.S.C. 503, are not 
recognized as separate entities for federal tax purposes.
    (4) Single owner organizations. Under Secs. 301.7701-2 and 
301.7701-3, certain organizations that have a single owner can choose 
to be recognized or disregarded as entities separate from their owners.
    (b) Classification of organizations. The classification of 
organizations that are recognized as separate entities is determined 
under Secs. 301.7701-2, 301.7701-3, and 301.7701-4 unless a provision 
of the Internal Revenue Code (such as section 860A addressing Real 
Estate Mortgage Investment Conduits (REMICs)) provides for special 
treatment of that organization. For the classification of organizations 
as trusts, see Sec. 301.7701-4. That section provides that trusts 
generally do not have associates or an objective to carry on business 
for profit. Sections 301.7701-2 and 301.7701-3 provide rules for 
classifying organizations that are not classified as trusts.
    (c) Qualified cost sharing arrangements. A qualified cost sharing 
arrangement that is described in Sec. 1.482-7 of this chapter and any 
arrangement that is treated by the Commissioner as a qualified cost 
sharing arrangement under Sec. 1.482-7 of this chapter is not 
recognized as a separate entity for purposes of the Internal Revenue 
Code. See Sec. 1.482-7 of this chapter for the proper treatment of 
qualified cost sharing arrangements.
    (d) Domestic and foreign entities. For purposes of this section and 
Secs. 301.7701-2 and 301.7701-3, an entity is a domestic entity if it 
is created or organized in the United States or under the law of the 
United States or of any State; an entity is foreign if it is not 
domestic. See sections 7701(a)(4) and (a)(5).
    (e) State. For purposes of this section and Sec. 301.7701-2, the 
term State includes the District of Columbia.
    (f) Effective date. The rules of this section are effective as of 
January 1, 1997.


Sec. 301.7701-2  Business entities; definitions.

    (a) Business entities. For purposes of this section and 
Sec. 301.7701-3, a business entity is any entity recognized for federal 
tax purposes (including an entity with a single owner that may be 
disregarded as an entity separate from its owner under Sec. 301.7701-3) 
that is not properly classified as a trust under Sec. 301.7701-4 or 
otherwise subject to special treatment under the Internal Revenue Code. 
A business entity with two or more members is classified for federal 
tax purposes as either a corporation or a partnership. A business 
entity with only one owner is classified as a corporation or is 
disregarded; if the entity is disregarded, its activities are treated 
in the same manner as a sole proprietorship, branch, or division of the 
owner.
    (b) Corporations. For federal tax purposes, the term corporation 
means--
    (1) A business entity organized under a Federal or State statute, 
or under a statute of a federally recognized Indian tribe, if the 
statute describes or refers to the entity as incorporated or as a 
corporation, body corporate, or body politic;
    (2) An association (as determined under Sec. 301.7701-3);
    (3) A business entity organized under a State statute, if the 
statute describes or refers to the entity as a joint-stock company or 
joint-stock association;
    (4) An insurance company;
    (5) A State-chartered business entity conducting banking 
activities, if any of its deposits are insured under the Federal 
Deposit Insurance Act, as amended, 12 U.S.C. 1811 et seq., or a similar 
federal statute;
    (6) A business entity wholly owned by a State or any political 
subdivision thereof;
    (7) A business entity that is taxable as a corporation under a 
provision of the Internal Revenue Code other than section 7701(a)(3); 
and
    (8) Certain foreign entities--(i) In general. Except as provided in 
paragraphs (b)(8)(ii) and (d) of this section, the following business 
entities formed in the following jurisdictions:

American Samoa, Corporation
Argentina, Sociedad Anonima
Australia, Public Limited Company
Austria, Aktiengesellschaft
Barbados, Limited Company
Belgium, Societe Anonyme
Belize, Public Limited Company
Bolivia, Sociedad Anonima
Brazil, Sociedade Anonima
Canada, Corporation and Company
Chile, Sociedad Anonima
People's Republic of China, Gufen Youxian Gongsi
Republic of China (Taiwan), Ku-fen Yu-hsien Kung-szu
Colombia, Sociedad Anonima
Costa Rica, Sociedad Anonima
Cyprus, Public Limited Company
Czech Republic, Akciova Spolecnost
Denmark, Aktieselskab
Ecuador, Sociedad Anonima or Compania Anonima
Egypt, Sharikat Al-Mossahamah
El Salvador, Sociedad Anonima
Finland, Osakeyhtio/Aktiebolag
France, Societe Anonyme
Germany, Aktiengesellschaft
Greece, Anonymos Etairia
Guam, Corporation
Guatemala, Sociedad Anonima
Guyana, Public Limited Company
Honduras, Sociedad Anonima
Hong Kong, Public Limited Company
Hungary, Reszvenytarsasag
Iceland, Hlutafelag
India, Public Limited Company
Indonesia, Perseroan Terbuka
Ireland, Public Limited Company
Israel, Public Limited Company
Italy, Societa per Azioni
Jamaica, Public Limited Company
Japan, Kabushiki Kaisha
Kazakstan, Ashyk Aktsionerlik Kogham
Republic of Korea, Chusik Hoesa
Liberia, Corporation
Luxembourg, Societe Anonyme
Malaysia, Berhad
Malta, Partnership Anonyme
Mexico, Sociedad Anonima
Morocco, Societe Anonyme
Netherlands, Naamloze Vennootschap
New Zealand, Limited Company
Nicaragua, Compania Anonima
Nigeria, Public Limited Company
Northern Mariana Islands, Corporation
Norway, Aksjeselskap
Pakistan, Public Limited Company
Panama, Sociedad Anonima
Paraguay, Sociedad Anonima
Peru, Sociedad Anonima
Philippines, Stock Corporation
Poland, Spolka Akcyjna
Portugal, Sociedade Anonima
Puerto Rico, Corporation
Romania, Societe pe Actiuni
Russia, Otkrytoye Aktsionernoy Obshchestvo
Saudi Arabia, Sharikat Al-Mossahamah
Singapore, Public Limited Company
Slovak Republic, Akciova Spolocnost
South Africa, Public Limited Company
Spain, Sociedad Anonima
Surinam, Naamloze Vennootschap
Sweden, Publika Aktiebolag
Switzerland, Aktiengesellschaft
Thailand, Borisat Chamkad (Mahachon)
Trinidad and Tobago, Public Limited Company
Tunisia, Societe Anonyme
Turkey, Anonim Sirket
Ukraine, Aktsionerne Tovaristvo Vidkritogo Tipu
United Kingdom, Public Limited Company
United States Virgin Islands, Corporation
Uruguay, Sociedad Anonima
Venezuela, Sociedad Anonima or Compania Anonima

    (ii) Exceptions in certain cases. The following entities will not 
be treated as corporations under paragraph (b)(8)(i) of this section:
    (A) With regard to Canada, any corporation or company formed under 
any federal or provincial law which provides that the liability of all 
of the members of such corporation or company will be unlimited; and

[[Page 66590]]

    (B) With regard to India, a company deemed to be a public limited 
company solely by operation of Section 43A(1) (relating to corporate 
ownership of the company), section 43A(1A) (relating to annual average 
turnover), or section 43A(1B) (relating to ownership interests in other 
companies) of the Companies Act, 1956 (or any combination of these), 
provided that the organizational documents of such deemed public 
limited company continue to meet the requirements of section 3(1)(iii) 
of the Companies Act, 1956.
    (iii) Public companies. With regard to Cyprus, Hong Kong, Jamaica, 
and Trinidad and Tobago, the term public limited company includes any 
limited company which is not a private limited company under the laws 
of those jurisdictions.
    (iv) Limited companies. Any reference to a limited company (whether 
public or private) in paragraph (b)(8)(i) of this section includes, as 
the case may be, companies limited by shares and companies limited by 
guarantee.
    (v) Multilingual countries. Different linguistic renderings of the 
name of an entity listed in paragraph (b)(8)(i) of this section shall 
be disregarded. For example, an entity formed under the laws of 
Switzerland as a Societe Anonyme will be a corporation and treated in 
the same manner as an Aktiengesellschaft.
    (c) Other business entities. For federal tax purposes--
    (1) The term partnership means a business entity that is not a 
corporation under paragraph (b) of this section and that has at least 
two members.
    (2) Wholly owned entities--(i) In general. A business entity that 
has a single owner and is not a corporation under paragraph (b) of this 
section is disregarded as an entity separate from its owner.
    (ii) Special rule for certain business entities. If the single 
owner of a business entity is a bank (as defined in section 581), then 
the special rules applicable to banks will continue to apply to the 
single owner as if the wholly owned entity were a separate entity.
    (d) Special rule for certain foreign business entities--(1) In 
general. Except as provided in paragraph (d)(3) of this section, a 
foreign business entity described in paragraph (b)(8)(i) of this 
section will not be treated as a corporation under paragraph (b)(8)(i) 
of this section if--
    (i) The entity was in existence on May 8, 1996;
    (ii) The entity's classification was relevant (as defined in 
Sec. 301.7701-3(d)) on May 8, 1996;
    (iii) No person (including the entity) for whom the entity's 
classification was relevant on May 8, 1996, treats the entity as a 
corporation for purposes of filing such person's federal income tax 
returns, information returns, and withholding documents for the taxable 
year including May 8, 1996;
    (iv) Any change in the entity's claimed classification within the 
sixty months prior to May 8, 1996, occurred solely as a result of a 
change in the organizational documents of the entity, and the entity 
and all members of the entity recognized the federal tax consequences 
of any change in the entity's classification within the sixty months 
prior to May 8, 1996;
    (v) A reasonable basis (within the meaning of section 6662) existed 
on May 8, 1996, for treating the entity as other than a corporation; 
and
    (vi) Neither the entity nor any member was notified in writing on 
or before May 8, 1996, that the classification of the entity was under 
examination (in which case the entity's classification will be 
determined in the examination).
    (2) Binding contract rule. If a foreign business entity described 
in paragraph (b)(8)(i) of this section is formed after May 8, 1996, 
pursuant to a written binding contract (including an accepted bid to 
develop a project) in effect on May 8, 1996, and all times thereafter, 
in which the parties agreed to engage (directly or indirectly) in an 
active and substantial business operation in the jurisdiction in which 
the entity is formed, paragraph (d)(1) of this section will be applied 
to that entity by substituting the date of the entity's formation for 
May 8, 1996.
    (3) Termination of grandfather status--(i) In general. An entity 
that is not treated as a corporation under paragraph (b)(8)(i) of this 
section by reason of paragraph (d)(1) or (d)(2) of this section will be 
treated permanently as a corporation under paragraph (b)(8)(i) of this 
section from the earliest of:
    (A) The effective date of an election to be treated as an 
association under Sec. 301.7701-3;
    (B) A termination of the partnership under section 708(b)(1)(B) 
(regarding sale or exchange of 50 percent or more of the total interest 
in an entity's capital or profits within a twelve month period); or
    (C) A division of the partnership under section 708(b)(2)(B).
    (ii) Special rule for certain entities. For purposes of paragraph 
(d)(2) of this section, paragraph (d)(3)(i)(B) of this section shall 
not apply if the sale or exchange of interests in the entity is to a 
related person (within the meaning of sections 267(b) and 707(b)) and 
occurs no later than twelve months after the date of the formation of 
the entity.
    (e) Effective date. The rules of this section are effective as of 
January 1, 1997.


Sec. 301.7701-3  Classification of certain business entities.

    (a) In general. A business entity that is not classified as a 
corporation under Sec. 301.7701-2(b) (1), (3), (4), (5), (6), (7), or 
(8) (an eligible entity) can elect its classification for federal tax 
purposes as provided in this section. An eligible entity with at least 
two members can elect to be classified as either an association (and 
thus a corporation under Sec. 301.7701-2(b)(2)) or a partnership, and 
an eligible entity with a single owner can elect to be classified as an 
association or to be disregarded as an entity separate from its owner. 
Paragraph (b) of this section provides a default classification for an 
eligible entity that does not make an election. Thus, elections are 
necessary only when an eligible entity chooses to be classified 
initially as other than the default classification or when an eligible 
entity chooses to change its classification. An entity whose 
classification is determined under the default classification retains 
that classification (regardless of any changes in the members' 
liability that occurs at any time during the time that the entity's 
classification is relevant as defined in paragraph (d) of this section) 
until the entity makes an election to change that classification under 
paragraph (c)(1) of this section. Paragraph (c) of this section 
provides rules for making express elections. Paragraph (d) of this 
section provides special rules for foreign eligible entities. Paragraph 
(e) of this section provides special rules for classifying entities 
resulting from partnership terminations and divisions under section 
708(b). Paragraph (f) of this section sets forth the effective date of 
this section and a special rule relating to prior periods.
    (b) Classification of eligible entities that do not file an 
election--(1) Domestic eligible entities. Except as provided in 
paragraph (b)(3) of this section, unless the entity elects otherwise, a 
domestic eligible entity is--
    (i) A partnership if it has two or more members; or
    (ii) Disregarded as an entity separate from its owner if it has a 
single owner.
    (2) Foreign eligible entities--(i) In general. Except as provided 
in paragraph (b)(3) of this section, unless the entity elects 
otherwise, a foreign eligible entity is--

[[Page 66591]]

    (A) A partnership if it has two or more members and at least one 
member does not have limited liability;
    (B) An association if all members have limited liability; or
    (C) Disregarded as an entity separate from its owner if it has a 
single owner that does not have limited liability.
    (ii) Definition of limited liability. For purposes of paragraph 
(b)(2)(i) of this section, a member of a foreign eligible entity has 
limited liability if the member has no personal liability for the debts 
of or claims against the entity by reason of being a member. This 
determination is based solely on the statute or law pursuant to which 
the entity is organized, except that if the underlying statute or law 
allows the entity to specify in its organizational documents whether 
the members will have limited liability, the organizational documents 
may also be relevant. For purposes of this section, a member has 
personal liability if the creditors of the entity may seek satisfaction 
of all or any portion of the debts or claims against the entity from 
the member as such. A member has personal liability for purposes of 
this paragraph even if the member makes an agreement under which 
another person (whether or not a member of the entity) assumes such 
liability or agrees to indemnify that member for any such liability.
    (3) Existing eligible entities--(i) In general. Unless the entity 
elects otherwise, an eligible entity in existence prior to the 
effective date of this section will have the same classification that 
the entity claimed under Secs. 301.7701-1 through 301.7701-3 as in 
effect on the date prior to the effective date of this section; except 
that if an eligible entity with a single owner claimed to be a 
partnership under those regulations, the entity will be disregarded as 
an entity separate from its owner under this paragraph (b)(3)(i). For 
special rules regarding the classification of such entities for periods 
prior to the effective date of this section, see paragraph (f)(2) of 
this section.
    (ii) Special rules. For purposes of paragraph (b)(3)(i) of this 
section, a foreign eligible entity is treated as being in existence 
prior to the effective date of this section only if the entity's 
classification was relevant (as defined in paragraph (d) of this 
section) at any time during the sixty months prior to the effective 
date of this section. If an entity claimed different classifications 
prior to the effective date of this section, the entity's 
classification for purposes of paragraph (b)(3)(i) of this section is 
the last classification claimed by the entity. If a foreign eligible 
entity's classification is relevant prior to the effective date of this 
section, but no federal tax or information return is filed or the 
federal tax or information return does not indicate the classification 
of the entity, the entity's classification for the period prior to the 
effective date of this section is determined under the regulations in 
effect on the date prior to the effective date of this section.
    (c) Elections--(1) Time and place for filing--(i) In general. 
Except as provided in paragraphs (c)(1) (iv) and (v) of this section, 
an eligible entity may elect to be classified other than as provided 
under paragraph (b) of this section, or to change its classification, 
by filing Form 8832, Entity Classification Election, with the service 
center designated on Form 8832. An election will not be accepted unless 
all of the information required by the form and instructions, including 
the taxpayer identifying number of the entity, is provided on Form 
8832. See Sec. 301.6109-1 for rules on applying for and displaying 
Employer Identification Numbers.
    (ii) Further notification of elections. An eligible entity required 
to file a federal tax or information return for the taxable year for 
which an election is made under paragraph (c)(1)(i) of this section 
must attach a copy of its Form 8832 to its federal tax or information 
return for that year. If the entity is not required to file a return 
for that year, a copy of its Form 8832 must be attached to the federal 
income tax or information return of any direct or indirect owner of the 
entity for the taxable year of the owner that includes the date on 
which the election was effective. An indirect owner of the entity does 
not have to attach a copy of the Form 8832 to its return if an entity 
in which it has an interest is already filing a copy of the Form 8832 
with its return. If an entity, or one of its direct or indirect owners, 
fails to attach a copy of a Form 8832 to its return as directed in this 
section, an otherwise valid election under paragraph (c)(1)(i) of this 
section will not be invalidated, but the non-filing party may be 
subject to penalties, including any applicable penalties if the federal 
tax or information returns are inconsistent with the entity's election 
under paragraph (c)(1)(i) of this section.
    (iii) Effective date of election. An election made under paragraph 
(c)(1)(i) of this section will be effective on the date specified by 
the entity on Form 8832 or on the date filed if no such date is 
specified on the election form. The effective date specified on Form 
8832 can not be more than 75 days prior to the date on which the 
election is filed and can not be more than 12 months after the date on 
which the election is filed. If an election specifies an effective date 
more than 75 days prior to the date on which the election is filed, it 
will be effective 75 days prior to the date it was filed. If an 
election specifies an effective date more than 12 months from the date 
on which the election is filed, it will be effective 12 months after 
the date it was filed. If an election specifies an effective date 
before January 1, 1997, it will be effective as of January 1, 1997.
    (iv) Limitation. If an eligible entity makes an election under 
paragraph (c)(1)(i) of this section to change its classification (other 
than an election made by an existing entity to change its 
classification as of the effective date of this section), the entity 
cannot change its classification by election again during the sixty 
months succeeding the effective date of the election. However, the 
Commissioner may permit the entity to change its classification by 
election within the sixty months if more than fifty percent of the 
ownership interests in the entity as of the effective date of the 
subsequent election are owned by persons that did not own any interests 
in the entity on the filing date or on the effective date of the 
entity's prior election.
    (v) Deemed elections--(A) Exempt organizations. An eligible entity 
that has been determined to be, or claims to be, exempt from taxation 
under section 501(a) is treated as having made an election under this 
section to be classified as an association. Such election will be 
effective as of the first day for which exemption is claimed or 
determined to apply, regardless of when the claim or determination is 
made, and will remain in effect unless an election is made under 
paragraph (c)(1)(i) of this section after the date the claim for exempt 
status is withdrawn or rejected or the date the determination of exempt 
status is revoked.
    (B) Real estate investment trusts. An eligible entity that files an 
election under section 856(c)(1) to be treated as a real estate 
investment trust is treated as having made an election under this 
section to be classified as an association. Such election will be 
effective as of the first day the entity is treated as a real estate 
investment trust.
    (vi) Examples. The following examples illustrate the rules of this 
paragraph (c)(1):

    Example 1. On July 1, 1998, X, a domestic corporation, purchases 
a 10% interest in Y, an eligible entity formed under Country A law 
in 1990. The entity's classification was not relevant to any person 
for federal tax or information purposes prior to X's acquisition of 
an interest in Y. Thus, Y is not considered to be in existence on 
the effective date of this section for purposes of paragraph (b)(3) 
of this section. Under the applicable Country A

[[Page 66592]]

statute, all members of Y have limited liability as defined in 
paragraph (b)(2)(ii) of this section. Accordingly, Y is classified 
as an association under paragraph (b)(2)(i)(B) of this section 
unless it elects under this paragraph (c) to be classified as a 
partnership. To be classified as a partnership as of July 1, 1998, Y 
must file a Form 8832 by September 13, 1998. See paragraph (c)(1)(i) 
of this section. Because an election cannot be effective more than 
75 days prior to the date on which it is filed, if Y files its Form 
8832 after September 13, 1998, it will be classified as an 
association from July 1, 1998, until the effective date of the 
election. In that case, it could not change its classification by 
election under this paragraph (c) during the sixty months succeeding 
the effective date of the election.
    Example 2. (i) Z is an eligible entity formed under Country B 
law and is in existence on the effective date of this section within 
the meaning of paragraph (b)(3) of this section. Prior to the 
effective date of this section, Z claimed to be classified as an 
association. Unless Z files an election under this paragraph (c), it 
will continue to be classified as an association under paragraph 
(b)(3) of this section.
    (ii) Z files a Form 8832 pursuant to this paragraph (c) to be 
classified as a partnership, effective as of the effective date of 
this section. Z can file an election to be classified as an 
association at any time thereafter, but then would not be permitted 
to change its classification by election during the sixty months 
succeeding the effective date of that subsequent election.

    (2) Authorized signatures--(i) In general. An election made under 
paragraph (c)(1)(i) of this section must be signed by--
    (A) Each member of the electing entity who is an owner at the time 
the election is filed; or
    (B) Any officer, manager, or member of the electing entity who is 
authorized (under local law or the entity's organizational documents) 
to make the election and who represents to having such authorization 
under penalties of perjury.
    (ii) Retroactive elections. For purposes of paragraph (c)(2)(i) of 
this section, if an election under paragraph (c)(1)(i) of this section 
is to be effective for any period prior to the time that it is filed, 
each person who was an owner between the date the election is to be 
effective and the date the election is filed, and who is not an owner 
at the time the election is filed, must also sign the election.
    (d) Special rules for foreign eligible entities--(1) For purposes 
of this section, a foreign eligible entity's classification is relevant 
when its classification affects the liability of any person for federal 
tax or information purposes. For example, a foreign entity's 
classification would be relevant if U.S. income was paid to the entity 
and the determination by the withholding agent of the amount to be 
withheld under chapter 3 of the Internal Revenue Code (if any) would 
vary depending upon whether the entity is classified as a partnership 
or as an association. Thus, the classification might affect the 
documentation that the withholding agent must receive from the entity, 
the type of tax or information return to file, or how the return must 
be prepared. The date that the classification of a foreign eligible 
entity is relevant is the date an event occurs that creates an 
obligation to file a federal tax return, information return, or 
statement for which the classification of the entity must be 
determined. Thus, the classification of a foreign entity is relevant, 
for example, on the date that an interest in the entity is acquired 
which will require a U.S. person to file an information return on Form 
5471.
    (2) Special rule when classification is no longer relevant.--If the 
classification of a foreign eligible entity which was previously 
relevant for federal tax purposes ceases to be relevant for sixty 
consecutive months, the entity's classification will initially be 
determined under the default classification when the classification of 
the foreign eligible entity again becomes relevant. The date that the 
classification of a foreign entity ceases to be relevant is the date an 
event occurs that causes the classification to no longer be relevant, 
or, if no event occurs in a taxable year that causes the classification 
to be relevant, then the date is the first day of that taxable year.
    (e) Coordination with section 708(b). Except as provided in 
Sec. 301.7701-2(d)(3) (regarding termination of grandfather status for 
certain foreign business entities), an entity resulting from a 
transaction described in section 708(b)(1)(B) (partnership termination 
due to sales or exchanges) or section 708(b)(2)(B) (partnership 
division) is a partnership.
    (f) Effective date--(1) In general. The rules of this section are 
effective as of January 1, 1997.
    (2) Prior treatment of existing entities. In the case of a business 
entity that is not described in Sec. 301.7701-2(b) (1), (3), (4), (5), 
(6), or (7), and that was in existence prior to January 1, 1997, the 
entity's claimed classification(s) will be respected for all periods 
prior to January 1, 1997, if--
    (i) The entity had a reasonable basis (within the meaning of 
section 6662) for its claimed classification;
    (ii) The entity and all members of the entity recognized the 
federal tax consequences of any change in the entity's classification 
within the sixty months prior to January 1, 1997; and
    (iii) Neither the entity nor any member was notified in writing on 
or before May 8, 1996, that the classification of the entity was under 
examination (in which case the entity's classification will be 
determined in the examination).
    Par. 8. Section 301.7701-4 is amended as follows:
    1. The last sentence of paragraphs (b), (c)(1), (c)(2) Example 1, 
and (c)(2) Example 3 are revised.
    2. Paragraph (f) is added.
    The revisions and addition read as follows:


Sec. 301.7701-4  Trusts.

* * * * *
    (b) Business trusts. * * * The fact that any organization is 
technically cast in the trust form, by conveying title to property to 
trustees for the benefit of persons designated as beneficiaries, will 
not change the real character of the organization if the organization 
is more properly classified as a business entity under Sec. 301.7701-2.
    (c) * * *
    (1) * * * An investment trust with multiple classes of ownership 
interests ordinarily will be classified as a business entity under 
Sec. 301.7701-2; however, an investment trust with multiple classes of 
ownership interests, in which there is no power under the trust 
agreement to vary the investment of the certificate holders, will be 
classified as a trust if the trust is formed to facilitate direct 
investment in the assets of the trust and the existence of multiple 
classes of ownership interests is incidental to that purpose.
    (2) * * *
    Example 1. * * * As a consequence, the existence of multiple 
classes of trust ownership is not incidental to any purpose of the 
trust to facilitate direct investment, and, accordingly, the trust 
is classified as a business entity under Sec. 301.7701-2.
* * * * *
    Example 3. * * * Accordingly, the trust is classified as a 
business entity under Sec. 301.7701-2.

* * * * *
    (f) Effective date. The rules of this section generally apply to 
taxable years beginning after December 31, 1960. Paragraph (e)(5) of 
this section contains rules of applicability for paragraph (e) of this 
section. In addition, the last sentences of paragraphs (b), (c)(1), and 
(c)(2), Example 1 and Example 3 of this section, are effective as of 
January 1, 1997.
    Par. 9. Section 301.7701-6 is revised to read as follows:

[[Page 66593]]

Sec. 301.7701-6  Definitions; person, fiduciary.

    (a) Person. The term person includes an individual, a corporation, 
a partnership, a trust or estate, a joint-stock company, an 
association, or a syndicate, group, pool, joint venture, or other 
unincorporated organization or group. The term also includes a 
guardian, committee, trustee, executor, administrator, trustee in 
bankruptcy, receiver, assignee for the benefit of creditors, 
conservator, or any person acting in a fiduciary capacity.
    (b) Fiduciary--(1) In general. Fiduciary is a term that applies to 
persons who occupy positions of peculiar confidence toward others, such 
as trustees, executors, and administrators. A fiduciary is a person who 
holds in trust an estate to which another has a beneficial interest, or 
receives and controls income of another, as in the case of receivers. A 
committee or guardian of the property of an incompetent person is a 
fiduciary.
    (2) Fiduciary distinguished from agent. There may be a fiduciary 
relationship between an agent and a principal, but the word agent does 
not denote a fiduciary. An agent having entire charge of property, with 
authority to effect and execute leases with tenants entirely on his own 
responsibility and without consulting his principal, merely turning 
over the net profits from the property periodically to his principal by 
virtue of authority conferred upon him by a power of attorney, is not a 
fiduciary within the meaning of the Internal Revenue Code. In cases 
when no legal trust has been created in the estate controlled by the 
agent and attorney, the liability to make a return rests with the 
principal.
    (c) Effective date. The rules of this section are effective as of 
January 1, 1997.


Sec. 301.7701-7  [Removed]

    Par. 10. Section 301.7701-7 is removed.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 11. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


Sec. 602.101  [Amended]

    Par. 12. In Sec. 602.101, paragraph (c) is amended by adding a new 
entry in numerical order to the table to read as follows:


Sec. 602.101  OMB control numbers.

* * * * *
    (c) * * *

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                                                             Current OMB
     CFR part or section where identified and described      control No.
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301.7701-3.................................................    1545-1486
                                                                        
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Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: December 10, 1996.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 96-31997 Filed 12-17-96; 8:45 am]
BILLING CODE 4830-01-U