[Federal Register Volume 61, Number 93 (Monday, May 13, 1996)]
[Proposed Rules]
[Pages 21989-21997]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11780]



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DEPARTMENT OF THE TREASURY
26 CFR Part 301

[PS-43-95]
RIN 1545-AT91


Simplification of Entity Classification Rules

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that would replace 
the existing regulations for classifying certain business organizations 
with an elective regime. These proposed regulations simplify the 
existing classification rules.

DATES: Written comments and requests to speak (with outlines of oral 
comments) at a public hearing scheduled for August 21, 1996, at 10 a.m. 
must be submitted by August 12, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (PS-43-95), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (PS-43-95), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Armando 
Gomez, (202) 622-3050; concerning foreign organizations, Ronald M. 
Gootzeit or William H. Morris, (202) 622-3880; concerning submissions 
and the hearing, Evangelista Lee (202) 622-7190 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507).
    Comments on the collection of information should be sent 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, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224. 
Comments on the collection of information should be received by July 
12, 1996.
    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 collections of information are required by Secs. 301.6109-
1(b)(2)(vi) and 301.7701-3(c). This information is required by the IRS 
to ensure the proper classification of business organizations and to 
ensure compliance with the proposed regulations. The likely respondents 
are businesses and other for-profit organizations, including small 
businesses.
    Books or records relating to a collection 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.
    The burden of the collection of information required by 
Sec. 301.6109-1 will be reflected in Forms SS-4 and W-7. The burden of 
the collection of information required by Sec. 301.7701-3(c) will be 
reflected in such form as is prescribed by the Commissioner for 
purposes of making the election described in this regulation.

Introduction

    This document proposes to revise Secs. 301.7701-1 through 301.7701-
3 of the Procedure and Administration Regulations (26 CFR part 301) to 
clarify which organizations are classified as corporations 
automatically under the Internal Revenue Code (Code) and to provide a 
simple elective regime for classifying other business organizations. 
This document also proposes conforming changes to Secs. 1.581-1, 1.581-
2, and 1.761-1 of the Income Tax Regulations (26 CFR part 1), and to 
Secs. 301.6109-1, 301.7701-4, 301.7701-6, and 301.7701-7 of the 
Procedure and Administration Regulations (26 CFR part 301).

Background

    On April 3, 1995, Notice 95-14, relating to classification of 
business organizations under section 7701, was published in the 
Internal Revenue Bulletin (1995-1 C.B. 297). 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. After consideration of the comments, the Treasury Department 
and the IRS propose to replace the existing classification regulations 
with a simplified regime that is elective for certain business 
organizations.

Explanation of Provisions

I. Introduction

    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. However, many states have revised their statutes to 
provide that partnerships and other unincorporated organizations may 
possess characteristics that traditionally have been associated with 
corporations, thereby narrowing considerably the traditional 
distinctions between

[[Page 21990]]

corporations and partnerships under local law. For example, some 
partnership statutes now provide that no partner is unconditionally 
liable for all of the debts of the partnership. Similarly, almost all 
states have enacted statutes allowing the formation of limited 
liability companies. These entities provide protection from liability 
to all members but may qualify as partnerships for federal tax purposes 
under the existing regulations. See, e.g., Rev. Rul. 88-76 (1988-2 C.B. 
360).
    One consequence of the increased flexibility under local law in 
forming a partnership or other unincorporated business organization is 
that taxpayers generally can achieve partnership tax classification for 
a nonpublicly traded organization that, in all meaningful respects, is 
virtually indistinguishable from a corporation. To accomplish this, 
however, taxpayers and the IRS must expend considerable resources on 
classification issues. For example, since the issuance of Rev. Rul. 88-
76, the IRS has issued seventeen revenue rulings analyzing individual 
state limited liability company statutes, and has issued several 
revenue procedures and numerous letter rulings relating to 
classification of various business organizations. Meanwhile, small 
business organizations may lack the resources and expertise to achieve 
the tax classification they want under the current classification 
regulations.
    Reacting to the fact that publicly traded entities could easily 
qualify as partnerships, in 1987 Congress enacted section 7704 to 
require most publicly traded partnerships to be taxable as 
corporations. Thus, even if an organization could be classified as a 
partnership under the current regulations, it will nevertheless be 
classified as a corporation in most cases if its ownership interests 
are publicly traded.
    In light of these developments, Treasury and the IRS believe that 
it is appropriate to replace the increasingly formalistic rules under 
the current regulations with a much simpler approach that generally is 
elective. To further simplify this area, the proposed regulations 
provide similar rules for organizations that have a single owner.
    With respect to foreign organizations, Notice 95-14 (1995-1 C.B. 
297) observed that, while the distinctions are similarly formalistic, 
the classification process under the current regulations involves even 
more complexities and requires greater resources than does the 
classification process for domestic organizations. For example, the 
classification of a foreign organization involves not only a review of 
organizational documents, but also a thorough understanding of the 
controlling foreign law. Accordingly, the simplified system provided 
under the proposed regulations extends to foreign organizations as 
well, with certain modifications explained below.
    In light of the increased flexibility under an elective regime for 
the creation of organizations classified as partnerships, the Treasury 
Department and the IRS will continue to monitor carefully the uses of 
partnerships in the international context and will issue appropriate 
substantive guidance 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.
    To accomplish the changes described above, the proposed regulations 
would replace Secs. 301.7701-1, 301.7701-2, and 301.7701-3 with new 
regulations. In addition, conforming amendments would be made to 
Secs. 1.581-1, 1.581-2, 1.761-1, 301.6109-1, 301.7701-4, 301.7701-6, 
and 301.7701-7.

II. General Classification Rules

A. Business Entities
    Proposed Sec. 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 
(which is a matter of federal tax law). The proposed regulations 
explain that certain joint undertakings that are not entities under 
local law may nonetheless constitute separate entities for federal tax 
purposes; on the other hand, not all entities formed under local law 
are recognized as separate entities for federal tax purposes. For 
example, individuals who own property as tenants in common may create a 
separate entity for federal tax purposes if the individuals actively 
carry on a trade, business, financial operation, or venture and divide 
the profits therefrom. On the other hand, 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 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. See Rev. Rul. 94-16 (1994-1 C.B. 
19); Rev. Rul. 94-65 (1994-2 C.B. 14). Also, the proposed regulations 
retain the rule under the current regulations that a qualified cost 
sharing arrangement described in Sec. 1.482-7 is not a partnership for 
federal tax purposes.
    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 Real 
Estate Mortgage Investment Conduit (REMIC) rules, see section 860A(a)). 
The proposed regulations provide that trusts generally do not have 
associates or an objective to carry on business for profit. While these 
proposed regulations restate the distinction between trusts and 
business entities, the determination of whether an organization is 
classified as a trust for federal tax purposes is intended to remain 
the same as under current law.
    Proposed Sec. 301.7701-2 specifies those business entities that 
automatically are classified as corporations for federal tax purposes. 
Any other business entity that is recognized for federal tax purposes 
may choose its classification under the rules of proposed 
Sec. 301.7701-3. Those rules provide that a business entity with at 
least two members can be classified as either a partnership or an 
association, and that a business entity with a single member can be 
classified as an association or can be disregarded as an entity 
separate from its owner.
B. Corporations
    The proposed regulations clarify 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 or a U.S. 
possession, territory, or commonwealth. Each of these categories is 
described briefly below.
    The proposed regulations define corporation to include any business 
entity recognized for federal tax purposes that is organized under a 
Federal or State statute, or under a statute of a federally recognized 
Indian tribe, that describes or refers to the entity as incorporated or 
as a corporation, body corporate, or body politic. Such entities 
include governmentally chartered corporations, as well as business 
corporations. See, e.g., 12 U.S.C. 21 et seq. (national banking 
associations), 20 U.S.C. 1087-2 (Student Loan Marketing Association),

[[Page 21991]]

and 36 U.S.C. 1101 (private corporations established under federal 
law).
    The proposed regulations define an association by reference to 
Sec. 301.7701-3. As discussed in detail below, that section permits 
certain business entities to choose whether to be classified as an 
association or as a partnership (or, if the entity has a single owner, 
as a non-entity).
    The proposed regulations define a joint-stock company as a business 
entity organized under a State statute that describes or refers to the 
entity as a joint-stock company or joint-stock association. These 
entities typically have a fixed capital stock divided into shares 
represented by certificates transferable only upon the books of the 
company, manage their affairs by a board of directors and executive 
officers, and conduct their business in the general form and mode of 
procedure of a corporation. See Burk-Waggoner Oil Assoc. v. Hopkins, 
269 U.S. 110, 113 (1925).
    The proposed regulations define an insurance company as a business 
entity that is taxable as an insurance company under subchapter L, 
chapter 1 of the Code.
    Under the proposed regulations, a state-chartered bank is 
classified as a corporation if any of the bank's deposits are insured 
under the Federal Deposit Insurance Act, as amended, 12 U.S.C. 1811 et 
seq., or a similar federal statute. This rule reflects Congress 
requirement that these organizations be incorporated to be eligible for 
federal deposit insurance, see 12 U.S.C. 1813(a)(2), and provides 
comparable tax treatment to state-chartered banks and national banks 
chartered under the National Bank Act, 12 U.S.C. 21 et seq. (which 
characterizes national banks as corporations, see 12 U.S.C. 24). It 
also is consistent with Congress historical treatment of banks as 
corporations, as reflected in section 581 of the Code, which requires a 
bank to be incorporated for purposes of subchapter H of chapter 1. 
Under this rule, however, an unincorporated organization that conducts 
banking activities but that does not have federal deposit insurance, 
may, under proposed Sec. 301.7701-3, choose not to be an association 
for federal tax purposes; in that case, however, the organization is 
not a bank within the meaning of section 581, and thus is not eligible 
for treatment under subchapter H.
    The proposed regulations also classify as corporations 
organizations that are recognized for federal tax purposes if they are 
wholly owned by a State, or any political subdivision thereof. 
Organizations wholly owned by a State that are not an integral part of 
the State must be recognized for federal tax purposes and scrutinized 
under section 115 (which excludes from gross income any income derived 
from the exercise of any essential governmental function and accruing 
to a State or any political subdivision thereof, or the District of 
Columbia). Accordingly, the proposed regulations classify any such 
organization as a corporation. Nevertheless, under section 115, the 
organization's income may not be subject to federal income tax.
    The proposed regulations define corporation to include any business 
entity that is taxable as a corporation under another provision of the 
Code. For example, a business entity that is publicly traded within the 
meaning of section 7704 (and not within the exception in section 
7704(c)), is taxable as a corporation. Similarly, a business entity 
that is a taxable mortgage pool under section 7701(i) is taxable as a 
corporation.
    Finally, the proposed regulations classify as corporations certain 
foreign business entities (including entities organized in U.S. 
possessions, territories, and commonwealths) that are listed in the 
regulations. Notice 95-14 observed that current law does not 
automatically classify any foreign entity as a corporation by reference 
to the juridical status or designation of that entity under local law. 
That is, current law does not identify the foreign analogue to the 
incorporated state law entity that is always classified as a 
corporation for federal tax purposes, even though section 7701(a)(3) 
makes no distinction between domestic and foreign entities. Rather, 
since the issuance of Rev. Rul. 88-8 (1988-1 C.B. 403), all foreign 
entities have been classified based on the characteristics set forth in 
Secs. 301.7701-2 and 301.7701-3 of the current regulations. 
Nevertheless, under this approach, those foreign entities that are 
equivalent to state law corporations are virtually always classified as 
corporations.
    To ensure the corporate classification of these foreign entities, 
the proposed regulations include a list of foreign business entities 
that always will be classified as corporations. Several commentators 
supported inclusion of a list of foreign business entities that either 
would be treated as corporations per se or that would continue to be 
classified under the current regulations. The Treasury Department and 
the IRS believe that classifying the business entities on the list as 
corporations in all cases is consistent with the goal of simplifying 
the entity classification area. The organizations listed are limited 
liability entities, such as the British Public Limited Company, the 
French Societe Anonyme, and the German Aktiengesellschaft. The Treasury 
Department and the IRS invite comments on the composition of the list.
    Under a special grandfather rule, however, an entity described in 
this list will nevertheless be classified as a partnership under the 
proposed regulations if: (1) The entity was in existence and claimed to 
be a partnership on May 8, 1996 and for all prior periods, (2) that 
classification was relevant to any person for federal tax purposes at 
any time during the period that includes May 8, 1996, (3) the entity 
had a reasonable basis (within the meaning of section 6662) for 
claiming partnership classification, and (4) neither the entity nor any 
member has been notified in writing on or before May 8, 1996 that the 
classification of the entity is under examination (in which case the 
entity's classification will be determined in the examination).
    When these regulations become final, and current Sec. 301.7701-2 
(on which Rev. Rul. 88-8 is based) is superseded, Rev. Rul. 88-8 will 
be obsolete.
C. Other Business Entities
    The proposed regulations define the term partnership to include any 
business entity that has at least two members and that is not 
classified as a corporation.
    Some commentators requested clarification of the effect of these 
elective classification rules on an organization's ability to elect to 
be excluded from subchapter K under section 761. The proposed 
regulations do not change the existing requirements for the election 
provided in Sec. 1.761-2. Accordingly, an organization that is 
classified as a partnership under the proposed regulations may elect to 
be excluded from subchapter K, if it qualifies under Sec. 1.761-2.
    Many commentators requested guidance concerning the classification 
of an unincorporated business entity with a single owner. Some 
commentators suggested that these entities be treated as sole 
proprietorships, while others suggested partnership classification. 
Because a fundamental characteristic of a partnership is the presence 
of associates, an entity with a single owner cannot conduct business as 
a partnership. However, the proposed regulations permit a business 
entity with a single owner that is not required to be classified as a 
corporation to elect to be classified as an association or to have the 
organization disregarded as an

[[Page 21992]]

entity separate from its owner (in which case the business activity is 
treated for federal tax purposes in the same manner as if it were 
conducted as a sole proprietorship, branch, or division of the 
organization's owner).

III. Elective Classification of Certain Entities

A. In General
    Proposed Sec. 301.7701-3 sets forth rules permitting a business 
entity that is not required to be classified as a corporation (referred 
to in the regulation as an eligible entity) to elect its classification 
for federal tax purposes. An eligible entity that has at least two 
members may elect to be classified as an association or a partnership, 
and an eligible entity with a single owner may elect to be classified 
as an association or to be disregarded as an entity separate from its 
owner.
B. Default Classification
    The proposed regulations are designed to provide most eligible 
entities with the classification they would choose without requiring 
them to file an election. Thus, the proposed regulations provide 
default classification rules that aim to match expectations. An 
eligible entity that wants the default classification need not file an 
election.
    1. Domestic eligible entities. Notice 95-14 suggested partnership 
default for domestic eligible entities. The comments supported this 
rule, and the proposed regulations adopt it. Thus, a newly formed 
domestic eligible entity will be classified as a partnership if it has 
two or more members unless an election is filed to classify the entity 
as an association; no affirmative action need be taken by the entity to 
ensure partnership classification. Similarly, if that entity has a 
single member, it will not be treated as an entity separate from its 
owner for federal tax purposes unless an election is filed to classify 
the organization as an association.
    2. Foreign eligible entities. Notice 95-14 suggested association 
default for foreign eligible entities. The Notice indicated that while 
domestic eligible entities typically are formed with an intent to 
obtain partnership classification, the preferred classification of 
foreign eligible entities is less predictable. For example, the Notice 
expressed concern that because partnership default could subject some 
foreign entities to compliance requirements and excise tax liability 
under section 1491, an entity should not be classified as a partnership 
inadvertently. On the other hand, as some commentators indicated, 
association default might not match the expectations of a foreign 
eligible entity.
    In response to these comments, the proposed regulations provide a 
default rule that should match expectations more closely. The Treasury 
Department and IRS believe that if any of an organization's members has 
personal liability for the debts of the organization, the expectation 
is that the organization will be classified as a partnership. 
Accordingly, the proposed regulations provide that if one or more of an 
eligible entity's members have unlimited liability, the entity will be 
classified as a partnership if it has two or more members, or it will 
be disregarded as a separate entity if it has a single owner. Only if 
all of the entity's members have limited liability will the entity's 
default classification be association.
    For purposes of this rule, a member of a foreign entity has limited 
liability only if, based solely on the controlling statute or law 
pursuant to which the entity is organized, the member's personal 
liability for the debts of or claims against the entity is specifically 
limited (for example, to the amount of the member's unpaid capital 
contribution or to the amount of a statutorily limited guarantee). If 
protection from personal liability is optional under the applicable 
law, the entity's organizational documents will determine which option 
applies. The determination whether there is limited liability for 
purposes of the default rule is intended to be simpler and more 
straightforward than under current law, to ensure that the default 
classification is readily apparent. Thus, the limited liability inquiry 
generally will focus solely on controlling statutes as interpreted by 
judicial or administrative review. As a result, a member's ability to 
satisfy creditors' claims would not be relevant. If taxpayers remain 
uncertain whether there is limited liability in a particular case, they 
may file an election to secure the desired classification.
    3. Existing eligible entities. Commentators suggested that special 
rules should be provided for eligible entities formed prior to the 
effective date of the regulations. These commentators were concerned 
that some existing eligible entities would be required to file 
classification elections immediately to prevent their classification 
from being changed under a default rule. Under the proposed 
regulations, eligible entities existing prior to the effective date of 
the regulations that choose to retain their current classification 
would not be required to file an election. Rather, those entities would 
retain the classification claimed under the existing regulations 
(except that, if an eligible entity with a single owner claimed to be a 
partnership under the current regulations, the entity would be 
disregarded as an entity separate from its owner under this default 
rule). A foreign entity is considered such an existing entity only if 
its classification immediately prior to the effective date of these 
regulations is relevant to any person for federal tax purposes; other 
foreign entities formed prior to the effective date of these 
regulations would be considered new entities at the time that their 
federal tax classification became relevant and, therefore, would be 
required to file a classification election or be classified under the 
general default rule described above.
    Furthermore, under a transition rule discussed below, the IRS 
generally will not challenge an existing entity's claimed 
classification for periods to which the existing regulations apply if 
the entity had a reasonable basis for the claimed classification.
C. Elections
    1. In general. An eligible entity that does not want the 
classification provided by the applicable default provision, or that 
wants to change its classification, may file an election to obtain the 
chosen classification. Some commentators suggested that the election be 
made with Form SS-4 (Application for Employer Identification Number); 
others suggested that the election be made with the filing of the 
entity's first tax return.
    An eligible entity may elect its classification by filing an 
election with the appropriate service center. The proposed regulations 
would require that the election specify the name, address, and taxpayer 
identifying number of the entity, the chosen classification, whether 
the election results in a change in classification, and whether the 
entity is a domestic or foreign entity. It is anticipated that the 
Commissioner will prescribe a form for this purpose, in which case 
elections must be made on such form. The election will be effective on 
a date specified on the election if that date is not more than 75 days 
prior to the date on which the election is filed, or on the date filed 
if no such date is specified on the election. In addition to the 
original election, a business entity that makes an election shall file 
a copy of its election with its federal tax return for the year in 
which the election is effective. If the entity is not required to file 
a return, the Commissioner will require direct or indirect owners of 
the

[[Page 21993]]

entity to include copies of the election with their federal tax 
returns.
    Notice 95-14 suggested that all the members of an electing eligible 
entity would be required to consent unanimously to a classification 
election. Most commentators stated that, although an indication of 
unanimity may be appropriate, a requirement that each member sign the 
election could cause significant administrative difficulties. In 
response to these comments, the proposed regulations require that an 
election be signed by: (1) Each member of the entity, or (2) any 
officer, manager, or owner who is authorized to make the election and 
who represents to having such authorization under penalties of perjury.
    An electing eligible entity also would be required to provide its 
Employer Identification Number (EIN) on the election form. To reduce 
taxpayers' paperwork burdens when an existing entity elects to change 
its classification, the proposed regulations provide that if the entity 
already has an EIN, it will retain it even though it elects to change 
its tax classification. Any organization without an EIN at the time it 
files its election, including an organization that had not previously 
been treated as a separate entity for federal tax purposes, must apply 
for an EIN on Form SS-4 when it files its election. If a new single-
member entity elects to be disregarded as an entity separate from its 
owner, then the taxpayer identifying number of its owner must be 
displayed on the election. The proposed regulations amend 
Sec. 301.6109-1 to reflect these requirements.
    2. Special rule for exempt organizations. A special rule is 
provided for eligible entities that have been determined to be, or 
claim to be, exempt from taxation under section 501(a). A substantial 
majority of exempt organizations (including those employee plans that 
qualify under section 401(a)) will not be eligible entities, either 
because they are properly classified as trusts for federal tax purposes 
or because they are not-for-profit corporations. However, for those 
exempt organizations that are eligible entities, the business entity 
classification that is consistent with the claim for exemption is 
association (taxable as a corporation). Accordingly, the proposed 
regulations provide that a claim or determination of exempt status by 
an eligible entity is treated as an election to be classified as an 
association. Such elections will take effect on 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 to change that classification after the date that 
either the claim is withdrawn or rejected or the determination is 
revoked.
    3. Limits on changes in classification by election. Notice 95-14 
requested comments on whether the regulations should restrict elections 
to change an entity's classification. To varying degrees, commentators 
supported such a restriction. Under the proposed regulations, an 
eligible entity that makes an election to change its classification 
cannot change its classification by election again during the sixty 
months succeeding the effective date of the election. However, an 
existing entity that elects to change its classification as of the 
effective date of the proposed regulations may elect to change again 
within the first sixty months following the effective date.
    The sixty month limitation only applies to a change in 
classification by election. Thus, if a new eligible entity elects out 
of its default classification effective from its inception, that 
election is not a change in the entity's classification. Furthermore, 
the limitation does not apply if the organization's business actually 
is transferred to another entity. For example, an organization could 
liquidate into its parent, terminate and reform as another entity 
(e.g., by merger), or contribute its business to another organization 
without restriction.
    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.
D. Certain Partnership Terminations
    Under section 708(b)(1)(B), a partnership is considered terminated 
if within a twelve month period there is a sale or exchange of fifty 
percent or more of the total interests in partnership capital and 
profits. Under this rule, a termination is treated as a liquidation of 
the existing partnership and the formation of a new partnership. 
Accordingly, if an existing partnership terminates under section 
708(b)(1)(B), the newly created entity will be classified as a 
partnership (but could elect to change its classification thereafter).

IV. Effective Date and Transition Rules

    The regulations are proposed to apply generally for periods 
beginning on or after the date the final regulations are published in 
the Federal Register. Sections 301.7701-1 through 301.7701-3 will 
continue to apply until these regulations are effective.
    In addition, the IRS will not challenge the classification of an 
existing eligible entity, or an existing entity described in the list 
of foreign entities that are classified as corporations under the 
proposed regulations, for periods to which the current regulations 
apply if: (1) The entity had a reasonable basis (within the meaning of 
section 6662) for its claimed classification, (2) the entity claimed 
that same classification in all prior years, and (3) neither the entity 
nor any member has been notified in writing on or before May 8, 1996 
that the classification of the entity is under examination (in which 
case the entity's classification will be determined in the 
examination).

Special Analyses

    It has been determined that this notice of proposed rulemaking 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 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for Wednesday, August 21, 1996, 
at 10 a.m. in the Auditorium of the Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Because of access 
restrictions, visitors will not be admitted beyond the Internal Revenue 
Building lobby more than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by August 12, 1996 and submit an outline of the 
topics to be discussed and the time to be devoted to each topic (signed 
original and eight (8) copies) by August 12, 1996.

[[Page 21994]]

    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Armando Gomez of the 
Office of Assistant Chief Counsel (Passthroughs and Special Industries) 
and Ronald M. Gootzeit and William H. Morris 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.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are proposed to be 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  Tax on banks.

    (a) For an institution to be a bank for purposes of section 581, it 
must be a corporation for federal tax purposes. See Sec. 301.7701-2(b) 
of this chapter for the definition of corporation.
    (b) This section applies to taxable years beginning on or after the 
date that final regulations are published in the Federal Register.


Sec. 1.581-2  [Amended]

    Par. 3. In Sec. 1.581-2, paragraph (a) is amended by removing the 
first sentence.
    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.
* * * * *

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, as proposed to be amended in project 
number INTL-0024-94, published on June 8, 1995, at 60 FR 30214, and 
INTL-062-90, INTL-0032-93, INTL-52-86, and INTL-52-94, published on 
April 22, 1996, at 61 FR 17666, is amended as follows:
    1. Paragraph (b)(2)(v) is amended by removing the language ``.'' at 
the end of the paragraph, and replacing it with the language ``; and''.
    2. Paragraph (b)(2)(vi) is added.
    3. The text of paragraph (d)(2) is redesignated as paragraph 
(d)(2)(i).
    4. A paragraph heading is added for newly designated paragraph 
(d)(2)(i).
    5. Paragraph (d)(2)(ii) is added.
    The revisions and additions read as follows:


Sec. 301.6109-1  Identifying numbers.

* * * * *
    (b) * * *
    (2) * * *
    (vi) 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 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 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. See Sec. 301.7701-3(e) as 
contained in 26 CFR Part 301 as revised as of April 1, 1996.
    (d) Domestic and foreign entities. For purposes of this section and

[[Page 21995]]

Sec. Sec. 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 apply to periods 
beginning on or after the date that final regulations are published in 
the Federal Register.


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) A business entity that is taxable as an insurance company under 
subchapter L, chapter 1 of the Internal Revenue Code;
    (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) Except as provided in paragraph (d) of this section, the 
following business entities formed in the following jurisdictions:

American Samoa, Corporation
Argentina, Sociedad Anonima
Aruba, Naamloze Vennootschap
Australia, Public Limited Company
Austria, Aktiengesellschaft
Barbados, Limited Company
Belize, Public Limited Company
Belgium, Societe Anonyme or Naamloze Vennootschap
Bolivia, Sociedad Anonima
Brazil, Sociedade Anonima
Canada, Corporation
Chile, Sociedad Anonima
People's Republic of China, Company Limited by Shares
Republic of China (Taiwan), Company Limited by Shares
Colombia, Sociedad Anonima
Costa Rica, Sociedad Anonima
Cyprus, Public Limited Company
Czech Republic, Akciova Spolecnost
Denmark, Aktieselskab
Ecuador, Sociedad Anonima or Compania Anonima
El Salvador, Sociedad Anonima
Egypt, Sharikat Al-Mossahamah
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 Terbatas
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
Netherlands Antilles, 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, Aktiebolag
Switzerland, Aktiengesellschaft or Societe Anonyme
Thailand, Borisat Chamkad (Machachon)
Trinidad & Tobago, Public Limited Company
Turkey, Anonim Sirket
Tunisia, Societe Anonyme
Ukraine, Aktsionerne Tovaristvo Vidkritogo Tipu
United Kingdom, Public Limited Company
United States Virgin Islands, Corporation
Uruguay, Sociedad Anonima
Venezuela, Sociedad Anonima or Compania Anonima

    (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; and
    (2) 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.
    (d) Special rule for certain foreign business entities. A foreign 
business entity described in paragraph (b)(8) of this section is 
classified as a partnership if--
    (1) The entity was in existence and claimed to be a partnership on 
May 8, 1996 and for all prior periods;
    (2) That classification was relevant to any person for federal tax 
purposes at any time during the period that includes May 8, 1996;
    (3) The entity had a reasonable basis (within the meaning of 
section 6662) for claiming partnership classification; and
    (4) Neither the entity nor any member has been notified in writing 
on or before May 8, 1996 that the classification of the entity is under 
examination (in which case the entity's classification will be 
determined in the examination).
    (e) Effective date. The rules of this section apply to periods 
beginning on or after the date that final regulations are published in 
the Federal Register.

[[Page 21996]]

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 member 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. Paragraph (c) of this 
section provides rules for making express elections. Paragraph (d) of 
this section provides a special rule for classifying an entity created 
pursuant to a termination of a partnership under section 708(b)(1)(B). 
Paragraph (e) 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--
    (A) A partnership if it has two or more members and any member has 
unlimited liability;
    (B) An association if no member has unlimited liability; or
    (C) Disregarded as an entity separate from its owner if it has a 
single owner that has unlimited liability.
    (ii) Definition of unlimited liability. For purposes of paragraph 
(b)(2)(i) of this section, a member of a foreign eligible entity has 
unlimited liability if the member has personal liability for the debts 
of or claims against the entity, by reason of being a member, based 
solely on the statute or law pursuant to which the entity is organized. 
A member has personal liability if creditors of the entity may seek 
satisfaction of debts of 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 such member for any such liability.
    (3) Existing eligible entities. 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. For special rules regarding the 
classification of such entities for periods prior to the effective date 
of this section, see paragraph (e)(2) of this section. For purposes of 
this paragraph, a foreign eligible entity is treated as being in 
existence prior to the effective date of this section only if the 
entity's classification is relevant to any person for federal tax 
purposes at any time during the period that includes the date 
immediately 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)(ii) and (iii) 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 an election with the appropriate service center. Such an 
election shall specify the name, address, and taxpayer identifying 
number of the entity, the chosen classification, whether the election 
results in a change in classification, and whether the entity is a 
domestic or foreign entity. The election will be effective on the date 
specified on the election if that date is not more than 75 days prior 
to the date on which the election is filed, or on the date filed if no 
such date is specified on the election. If the Commissioner prescribes 
a form for this purpose, the election shall be made on such form. See 
Sec. 301.6109-1 for rules on applying for and displaying Employer 
Identification Numbers.
    (ii) Limitation. If an eligible entity makes an election under this 
paragraph (c) 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), it cannot change its classification by election 
again during the sixty months succeeding the effective date of the 
election.
    (iii) Special rule for 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 date 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.
    (iv) 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 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 statute, no member of Y has 
unlimited 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 
paragraph (c) of this section to be classified as a partnership. To 
be classified as a partnership as of July 1, 1998, Y must file the 
election 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 election 
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 
paragraph (c) of this section 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 paragraph (c) of this 
section, it will continue to be classified as an association under 
paragraph (b)(3) of this section.
    (ii) Z files an election under paragraph (c) of this section 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. An election made under paragraph 
(c)(1)(i) of this section must be signed by--

[[Page 21997]]

    (i) Each member of the electing entity; or
    (ii) Any officer, manager, or member of the electing entity who is 
authorized to make the election and who represents to having such 
authorization under penalties of perjury.
    (3) Further notification of elections. An eligible entity required 
to file a federal tax return for the taxable year for which an election 
is made under paragraph (c)(1)(i) of this section shall attach a copy 
of the form filed in accordance with paragraph (c)(1)(i) of this 
section to its federal tax return for that year. If the entity is not 
required to file a return for that year, the Commissioner will require 
that a copy of such form be attached to the federal income tax 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.
    (d) Special rule for certain partnership terminations. When a 
partnership terminates by operation of section 708(b)(1)(B) (on the 
sale or exchange of fifty percent or more of the total interests in 
partnership capital or profits within a twelve month period), the 
resulting entity created by such termination is a partnership.
    (e) Effective date--(1) In general. The rules of this section apply 
to periods beginning on or after the date that final regulations are 
published in the Federal Register.
    (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 is in existence prior to the effective date of 
this section, the entity's claimed classification will be respected for 
all periods prior to the effective date of this section if--
    (i) The entity had a reasonable basis (within the meaning of 
section 6662) for its claimed classification;
    (ii) The entity claimed that same classification for all prior 
periods; and
    (iii) Neither the entity nor any member has been notified in 
writing on or before May 8, 1996 that the classification of the entity 
is 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 additions 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 apply to taxable years 
beginning on or after the date that final regulations are published in 
the Federal Register.
    Par. 9. Section 301.7701-6 is revised to read as follows:


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 on the 
date that final regulations are published in the Federal Register.


Sec. 301.7701-7  [Removed]

    Par. 10. Section 301.7701-7 is removed.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-11780 Filed 5-9-96; 8:45 am]
BILLING CODE 4830-01-U