“Blockers,” “Stoppers,” and the Entity Classification Rules
Willard B. Taylor*
Tax lawyers often refer to “blockers” or “stoppers”—what are these? Generi¬cally, a blocker or stopper is an entity inserted in a structure to change the character of the underlying income or assets, or both, to address entity quali¬fication issues, to change the method of reporting, or otherwise to get a result that would not be available without the use of more than one entity. One example, discussed further below, would be a case where a regulated invest¬ment company (RIC) organizes a foreign subsidiary to invest in commodities or otherwise makes investments that could not be made by the RIC directly without jeopardizing its qualification, and thus converts “bad” assets and income into assets (i.e., shares of the foreign subsidiary) and income (i.e., dividends, subpart F inclusions, and gains from sales of the shares) that are “good” for RIC qualification purposes. The structures vary in significance from, for example, changes in the taxable base to less consequential changes in the way the taxable base is reported. Some are innocent, in the sense of being blessed by the statute (such as the use of a taxable subsidiary of a real estate investment trust (REIT)), but others may require a leap of faith.
What follows is more of a compilation of these situations than a paper that takes a position on whether specific structures are appropriate or not. One reason for this lack of decisiveness is that the results can also be achieved by synthetic ownership structures or instruments—so the use of the entity classification rules for this purpose cannot be judged apart from the judg¬ments passed on those structures and instruments. Moreover, while the whole point of blockers and other tiered structures, as well as some synthetic owner¬ship structures, is to undercut statutory restrictions (for example, on what is “good” income for a RIC or on the kind and number of shareholders that an S corporation may have), it is nonetheless difficult to conclude that the use of tiered entities is invariably “bad” or “abusive” because in a significant number of cases the structures are expressly sanctioned by rulings or regulations, or explicitly or implicitly by the statute.
*Of Counsel, Sullivan & Cromwell LLP, New York, NY; Professor, Adjunct Faculty, New York University Law School; Yale University, B.A., 1962; LL.B, 1965.