Company Seeks Rehearing After Federal Circuit Reverses Dismissal of Refund Suit

In its April 16, 2008 decision reversing and remanding the lower court's decision, this Court concluded correctly that "[u]nder settled law, a company that ceases to exist may not act as agent for a consolidated group," Op. at 2, thus agreeing that "ceasing to exist" and "termination" for purposes of § 1.1502-77A are one and the same. It also concluded correctly that because BFI Inc. continued to exist under Delaware law, "Inc's failure to exist had to be demonstrated under federal tax law." Op. at 3.

In looking to federal law, the Court stated that the only federal authority that had been presented to support this proposition was § 301.7701-3(g)(1)(iii) , and that that particular regulation "does not apply to the facts of this case." Id. Believing that Appellee had pointed to "no other source of federal tax law that might support the contention that Inc. ceased to exist for purposes of filing for tax refunds for years before Inc.'s conversion to LLC," the Court ruled that Appellee had not established "the hypothetical demise of Inc." Id. at 4.

In fact, the "hypothetical demise of Inc." is precisely what occurred when BFI Inc., a taxable entity, became "disregarded" for federal tax purposes by operation of § 301.7701-3(a) and (b), which explains why neither party directly addressed the sua sponte basis for the Court's decision in the briefs. The literal application of § 301.7701-3(g)(1)(iii) was never an issue in this case because it was cited both by the court below and by Appellee only as an illustration of the consequence of an entity becoming disregarded -- i.e., it is deemed to be liquidated.

However, neither the Court of Federal Claims, nor the parties, nor the authorities discussed below treat § 301.7701-3(g)(1)(iii) as describing the only circumstance in which an entity that becomes disregarded is deemed to be liquidated for federal tax purposes.² As discussed below, the same consequence -- i.e., a deemed liquidation -- occurs even without reference to that specific regulation. Consequently, neither party disputes that that BFI Inc.'s conversion to a limited liability company (hereinafter abbreviated as "LLC") caused it to become a disregarded entity under § 301.7701-3(a) and (b), which was deemed to have liquidated.³See Gov't Br. at 39-40.

The Government's agreement that BFI Inc. was deemed to have liquidated was not a mere slip of the pen. It is well established by numerous IRS administrative rulings (referenced infra at 9-10, n. 7), as well as the learned treatises of tax scholars (referenced infra at 12), that whenever an entity that is taxable as a corporation becomes an "eligible entity" that is "disregarded" pursuant to §§ 301.7701-3(a) and (b), the conversion is treated as a liquidation of that entity for federal tax purposes. Further, an entity that has liquidated (or is deemed to have liquidated) is treated as having ceased to exist for federal tax purposes. See 65 Fed. Reg. 57755, 57756 (Sept. 26, 2000) (listing "liquidation" as one method by which an entity "cease[s] to exist" under the consolidated return regulations); Eisenberg v. Comm'r., 155 F.3d 50, 55 (2d Cir. 1998); 10 MERTENS LAW OF FED. INCOME TAX'N § 38E:19 (2005) ("When a corporation liquidates . . . the corporation ceases to exist.").

Based on the Court's analysis that ceasing to exist constitutes a termination of authority under § 1.1502-77A, if BFI Inc. ceased to exist for federal tax purposes when it converted into BFI LLC, the lower court's decision should have been affirmed. Because the Court has already concluded that it is appropriate to look to federal law rather than merely to state law as the Government had advocated, the only question presented for reconsideration in this Petition is whether Appellee established that BFI Inc. ceased to exist (and therefore terminated for purposes of § 1.1502-77A) without relying exclusively on § 301.7701-3(g)(1)(iii). The answer is that it did, citing § 301.7701-3(g)(1)(iii) only as an illustration of how a conversion from a taxable entity into a disregarded entity causes a liquidation, and relying on the well-established and uncontroverted proposition that, under § 301.7701-3(a) and (b) (cited by Appellee in its brief and at oral argument), BFI Inc. became a disregarded entity when it converted into BFI LLC.

Appellee now files this Petition for Panel Rehearing, recognizing that the invocation of this procedure is a serious matter, to be filed only after due deliberation. With that thought in mind, Appellee respectfully submits that the Court erred in concluding that no federal law applied which establishes that BFI Inc. ceased to exist for federal tax purposes when it converted into BFI LLC. Specifically, Appellee submits that the Court's analysis misconstrued the limited purpose for which the Court of Federal Claims and Appellee cited § 301.7701-3(g)(1)(iii), and overlooked the importance of § 301.7701-3(a) and (b). As discussed below, these provisions, taken together, demonstrate that BFI Inc. ceased to exist for federal tax purposes at the moment it converted to an LLC, and that the resulting deemed liquidation of the entity constituted a termination that caused the entity to lose its authority to act on behalf of the BFI consolidated group pursuant to § 1.1502-77A.

Because the Court's decision diverges so dramatically from broadly accepted, and heretofore uncontroverted, federal tax principles about the federal tax consequences of converting from a corporation to an LLC, the decision should be vacated and the appeal reinstated.

As a matter of federal tax law, when BFI Inc. converted to BFI LLC, it became a "disregarded entity" pursuant to §§ 301.7701-3(a) and (b). The regulatory analysis is straightforward and was not disputed by the Government.

The regulations define the term "eligible entity" to mean a business entity "that is not classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8)." § 301.7701-3(a). BFI LLC, a business entity, does not fall under any of these listed categories. Thus, when BFI Inc. converted to BFI LLC, the entity was no longer a corporation; it became an eligible entity for federal tax purposes.

An eligible entity with a single owner may elect to be classified as an association (which is treated as a corporation)⁴ or to be disregarded as an entity separate from its owner. Id. If an eligible entity with a single owner does not affirmatively elect to be treated as an association, it is classified by default as a disregarded entity. § 301.7701-3(b)(1)(ii). BFI LLC had only a single owner, Allied Waste North America, Inc. (A4.) Because BFI LLC never elected to be classified as an association, (A10), it was by default treated as a disregarded entity.

The Government's initial brief before this Court unequivocally endorsed this conclusion. See Gov't Br. at 40 ("...the Court of Federal Claims correctly recognized that the default classification of § 301.7701-3(b)(1)(ii) applied here . . ."). Indeed, the Government's description of how the default classification works is almost identical to Appellee's description. Compare Gov't Br. at 39-40 with App. Br. at 41-42. Therefore, under a plain reading of §§ 301.7701-3(a) and (b), and as acknowledged by the Government in this appeal, it is indisputable that the entity which converted from BFI Inc. to BFI LLC became an eligible entity that, by default, was disregarded for federal tax purposes.

B. The Only Way To Explain The Federal Tax Consequences Of A Corporation Becoming A Disregarded Entity Is To Treat Its Assets And Liabilities As Being Distributed In Liquidation Of The Entity.

Section 301.7701-2(a) states: "[I]f the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner." In other words, a "disregarded" entity is a treated as a non-entity -- a proverbial "tax nothing" -- for federal tax purposes. See, e.g., David S. Miller, "The Tax Nothing," 97 TNT 22-69 (Feb. 3, 1997). To conclude otherwise would undermine the very idea of "disregarding" BFI LLC as an entity separate from its owner.

The treatment of BFI LLC as a non-entity for federal tax purposes is a construct deliberately created by the entity classification regime of § 7701. To give effect to this construct, federal tax law must account for what happens to the assets and liabilities of an entity that becomes "disregarded." To say that nothing happened to those assets and liabilities would contradict the very idea that the entity was "disregarded." After all, the suggestion that a "disregarded" entity could, for example, continue to be treated as the "owner" of an asset for federal tax purposes would be to "regard," or respect the existence of that entity. Thus, a change in classification from a taxable entity to a disregarded entity "will have certain tax consequences that must be reported." T.D. 8697, 1997-1 C.B. 215.⁵ Specifically, the assets and liabilities of the disregarded entity are deemed distributed in liquidation of that entity, i.e., because they must be transferred from their former owner (the once regarded -- now disregarded -- entity that is no longer a taxpayer by reason of § 301.7701-3(a) and (b)) to their new owner, the sole owner of the disregarded entity.⁶

In sum, this Court's conclusion that BFI Inc., by converting to BFI LLC, did not cease to exist for federal tax purposes (or that BFI Inc. somehow continued to exist as a taxable entity after the conversion), contradicts the very idea of "disregarding" the converted entity, as required by default under the § 7701 regulations unless an election is made. If BFI Inc. did not cease to exist as an entity separate from BFI LLC, then the entity would be "regarded," contrary to the § 301.7701-3(a) and (b) regulations. Based upon this Court's ruling that federal law should determine whether BFI Inc. ceased to exist, its conclusion that BFI Inc. continued to exist for federal tax purposes cannot be reconciled with the operation of §§ 301.7701-3(a) and (b).

C. The Court Erred By Treating § 301.7701-3(g)(1)(iii) As The Exclusive Authority By Which A Taxable Entity That Converts To A Disregarded Entity May Be Treated As A "Liquidation" Of The Entity.

As with the conclusion that BFI LLC was, by default, a disregarded entity, the Government does not, and cannot, dispute that the conversion of BFI Inc. into BFI LLC was a deemed "liquidation" of the entity for federal tax purposes even though it did not fit the precise circumstances described in § 301.7701-3(g)(1)(iii). See Gov't Br. at 36 n. 8 (clarifying that "the deemed liquidation upon which the Court based its conclusion that BFI, Inc. terminated for federal tax purposes . . . was from BFI Inc. to its 'single owner.'") (citing § 301.7701-3(g)(1)(iii)). Any argument to the contrary would contradict numerous IRS administrative rulings that confirm this very conclusion.⁷ None of these rulings, where a liquidation was found to occur upon the conversion of a corporation to an LLC, depended on, or involved facts that fit within, § 301.7701-3(g)(1)(iii).

The preamble to the final § 7701 regulations also reflects that the deemed liquidation specifically referenced in § 301.7701-3(g)(1) is not exclusive, but merely an "example" of the tax consequences of a change in entity classification. It states:

The IRS does not treat § 301.7701-3(g)(1) as defining the universe of deemed liquidations either. The three scenarios discussed in § 301.7701-3(g)(1), which result in deemed liquidations, all involve elective changes in classification. Nevertheless, the IRS has recognized that a non-elective conversion to a disregarded entity also results in a deemed liquidation, citing to § 301.7701-3(g)(1) as support.

In Revenue Ruling 2004-59, 2004-1 C.B. 1050, the IRS "explain[ed] the federal tax consequences when an entity classified as a partnership for federal tax purposes converts into a state law corporation under a state statute that does not require an actual transfer of the unincorporated entity's assets or interests." This exact scenario -- where a partnership converts to a corporation under state law -- is not discussed in the entity classification regulations. Nevertheless, § 301.7701-3(g)(1)(i) describes an analogous circumstance, namely, where a partnership elects to be classified as an association for federal tax purposes. Citing to § 301.7701-3(g)(1)(i), the IRS ruled as follows:

The country's leading tax scholars have also affirmed this proposition. Bittker and Eustice, in their seminal treatise, state that "a change from corporate to non-corporate status will be treated as a deemed complete liquidation." BORIS BITTKER AND JAMES EUSTICE, Federal Income Taxation of Corporations and Shareholders, ¶ 2.03(b) (2007). As authority for this proposition, Bittker and Eustice cite to the same regulation cited by the Court of Federal Claims, § 301.7701-3(g)(1)(iii). Thus, like the court below, Bittker and Eustice do not view the specific circumstances in § 301.7701-3(g)(1)(iii) as the only instances where conversion to a disregarded entity is deemed a liquidation.⁸ Bittker & Eustice's statement is consistent with Appellee's assertions and with the IRS's own administrative rulings that the "deemed liquidation" principle applies whenever a taxable entity becomes a disregarded entity.

The new consolidated return regulation, § 1.1502-77(e)(1)(ii)(A), and its preamble also show that deemed liquidations -- that is, terminations for federal tax purposes -- occur whenever an entity is disregarded, not solely under the circumstances of § 301.7701-3(g)(1)(iii). Section 1.1502-77(e)(1)(ii)(A), drafted after the entity classification regulations came into effect, provides that "the existence of a corporation is deemed to terminate if . . . it becomes for federal tax purposes . . . disregarded as an entity separate from its owner." As the preamble to this regulation explained, the reason that the corporation is deemed terminated is that "a corporation's existence is deemed to cease not only if the corporation ceases to exist under applicable law, but also if the corporation becomes a disregarded entity." 65 Fed. Reg. 57755, 57757 (Sept. 26, 2000).

As the authorities cited in this Petition all demonstrate, it does not matter whether the entity becomes disregarded because it converts from a corporation to an LLC under state law, or because it first elected to be treated as an association and thereafter elected to be disregarded. In either case, a taxable entity ceases to exist if it becomes a disregarded entity; and as the Court has already held, an entity that has ceased to exist "may not act as agent for a consolidated group." Op. at 2.

To conclude that terminations occur only under the circumstances of § 301.7701-3(g)(1)(iii) is to ignore the plain application of § 301.7701-3(a) and (b). If nothing happens to a corporation that converts to a non-corporate entity unless it first elects to be treated as an association and then elects to be disregarded, then the default classification provisions of those regulations have no practical meaning or application.

Thus, the Court erred by treating § 301.7701-3(g)(1)(iii) as the exclusive authority by which an entity can be considered to have "liquidated" under the § 7701 regulations and therefore to have "terminated" for federal tax purposes. Section 301.7701-3(g)(1)(iii) may be the only place in the Code and Treasury Regulations to explicitly describe the substantive tax consequences of converting from a taxable entity to a disregarded entity, but as the other authorities cited in this Petition amply demonstrate, the same framework for treating a conversion of a taxable entity into one that is disregarded as a liquidation, even under facts that are not specifically addressed by the regulation, must apply for the entity classification rules to have any practical application under the tax law.

BFI Inc. ceased to exist and was terminated for federal tax purposes when it converted to an LLC on December 31, 2004. The entity thereafter lacked agency authority under § 1.1502-77A when the refund claims at issue were filed.

This Court's decision alters what has been, until now, a completely non-controversial tenet of modern corporate tax law and represents a wholesale upheaval of the entity classification regime. It is probably no exaggeration to point out that if corporations which convert to LLCs are considered to still exist for federal tax purposes, as this Court has ruled, there are probably thousands, if not tens of thousands, of converted LLCs that should be filing tax returns. Clearly, the IRS never intended this result when the entity classification rules were promulgated, nor would the Government agree with this proposition if the question were posed.

For the foregoing reasons, the Court's decision should be vacated and the appeal reinstated.

² Indeed, to Appellee's knowledge, there is not a single other case, IRS pronouncement or tax treatise that has ever interpreted the deemed liquidation construct under the § 7701 regulations to apply only under the specific facts of § 301.7701-3(g)(1)(iii) as this Court has held.

³ While not disputing that BFI Inc. was deemed to have liquidated, the Government argued that the "deemed liquidation is merely a tax construct used for purposes of determining the tax consequences of the election." Gov't Repl. at 15. The Government's principal argument on appeal was that the consolidated return regulations look only to state law, and not federal tax law, to determine whether there has been a "dissolution" or "termination" of the relevant entity. Gov't Br. at 30-38.

⁴ Prior to the elective entity classification rules under Code § 7701, the term "association" was used to classify an entity that had the characteristics of a corporation even though it was not formally chartered as such under the state's corporation law. See generally BORIS BITTKER AND JAMES EUSTICE, FEDERAL INCOME TAXATION OF CORPORATIONS AND SHAREHOLDERS, ¶ 2.02[1] (2007). These characteristics were eventually codified in the regulations under Code § 7701 in effect prior to the adoption of the entity classification regulations. Id. at ¶ 2.02[2]. When the entity classification regulations were adopted in 1997, the evaluation of corporate characteristics to determine an entity's tax status was replaced by an elective regime, giving unincorporated businesses the ability to elect their federal tax status. Under the elective regime, the term "association" has been employed to describe an "eligible entity" that elects to be treated as a corporation for federal tax purposes. § 301.7701-3(a).

⁵ T.D. 8697 is the preamble to the final § 7701 regulations, effective January 1, 1997. This authority was cited in App. Br. at 27.

⁶ The deemed liquidation of an entity invokes the provisions of Subchapter C of the Code to dictate the substantive tax consequences that result from the liquidation. Those provisions (in particular, Code § 332) apply to a deemed liquidation in the same manner as if an actual liquidation occurred. See, e.g., the IRS rulings cited in note 7, infra.

⁷See, e.g., IRS Priv. Ltr. Rul. 200812017 (Mar. 21, 2008) (treating the conversion of a corporation to an LLC that was disregarded as an entity separate from its owner for federal tax purposes as a liquidation of the corporation for these purposes); IRS Priv. Ltr. Rul. 200701018 (Jan. 5, 2007) (ruling that the merger of a corporation into an LLC that was disregarded as an entity separate from its owner for Federal tax purposes was a distribution by the corporation of all its assets to the owner in complete "liquidation" of the corporation under Code § 332); IRS Priv. Ltr. Rul. 200608016 (Feb. 24, 2006) (treating the conversion of some corporations into LLCs, and the merger of other corporations into LLCs, all of which were disregarded as entities separate from their owners for federal tax purposes, as complete liquidations of those corporations for purposes of Code § 332); IRS Priv. Ltr. Rul. 200220018 (May 17, 2002) (treating the conversion of an "S corporation" into a LLC that was disregarded as an entity separate from its owner for federal tax purposes as a "liquidation" of the corporation under Code § 332); see also IRS Priv. Ltr. Rul. 200813028 (Mar. 28, 2008) (requiring the taxpayer to represent that the conversion of a subsidiary into an LLC that was disregarded as an entity separate from its owner for Federal tax purposes was treated as a liquidation of the subsidiary and as though the subsidiary "ceased to exist" at such time); IRS Priv. Ltr. Rul. 200505009 (Feb. 5, 2005) (requiring the taxpayer to represent that the conversion of a corporation into an LLC that was disregarded as an entity separate from its owner for federal tax purposes was a complete "liquidation" pursuant to Code § 332).

⁸ Bittker and Eustice refer to a change from "corporate to non-corporate status," not from an "association" to a "disregarded entity," even though their text cites the same regulation that Appellee, the Court of Federal Claims, and the Government each cited for the same proposition.