Transcript Document

OR
“But I don't want to
go among mad
people,” said Alice.
“Oh, you can't help
that,” said the cat.
“We're all mad
here.”
Dallas CPA Society
7th Annual Education Conference
May 26, 2011
Hilton Anatole Hotel, Dallas
C. CLINTON DAVIS, JR.
KRAGE & JANVEY, L.L.P.
2100 ROSS AVENUE—SUITE 2600
DALLAS, TEXAS 75201
[email protected]
ANY TAX ADVICE CONTAINED HEREIN WAS NOT
INTENDED OR WRITTEN TO BE USED AND CANNOT BE
USED BY ANY TAXPAYER FOR THE PURPOSE OF (1)
AVOIDING PENALTIES THAT MAY BE IMPOSED ON THE
RECIPIENT OR ANY TAXPAYER OR (2) PROMOTING,
RECOMMENDING OR MARKETING TO ANOTHER PARTY
ANY TRANSACTION OR MATTER DISCUSSED HEREIN.
THESE MATERIALS WERE PREPARED ON APRIL 13, 2011
AND DO NOT REFLECT ANY REGULATORY OR OTHER
DEVELOPMENTS ON OR AFTER THAT DATE.
4

Kansas professional LLP argued that
allocations to its partners were not
subject to self-employment tax because
each should be considered a limited
partner's interest in a limited partnership
for purposes of Section 1402(a)(13) ,
which is an exclusion from the general
self-employment tax rule. Interests were
designated as limited partnership
interests in the law firm's organizational
documents and their interests enjoyed
limited liability pursuant to Kansas law.
5


The intent of Section 1402(a)(13) was to ensure that
individuals who merely invested in a partnership
and who were not actively participating in the
partnership's business operations would not
receive credits toward Social Security coverage.
The legislative history of Section 1402(a)(13) did
not support a holding that Congress wanted to
exclude partners who performed services for a
partnership in their capacity as partners (i.e.,
acting as self-employed persons) from liability for
self-employment taxes.
6

Partners had contributed only a nominal
amount for their partnership units, so it was
clear that their distributive share of the law
firm's income was not a return on their
investment.


IS THE TAX COURT WILLING TO TRACE???
Thus, the court found that the attorneys'
distributive shares arising from their legal
services were subject to self employment taxes.
7

BEWARE professionals who have been
setting their practices up as:



limited partnerships,
limited laibility partnerships, or
professional limited liability companies
and relying on the limited partner exception of
Section 1402(a)(13) to not pay self-employment
tax!
8
•Actual
distributions made annually;
•As
to the income, (1) there was no steady flow of
income, and (2) distribution of profits was in the
discretion of the general partner;
•The
partnership agreement specifically stated that
distributions are secondary to the partnership's primary
purpose of generating a long-term reasonable rate of
return.
•No
ability to withdraw capital;
•Right
of first refusal for transfers but no time
limit for exercising the purchase option with
respect to a voluntary transfer;
•Court
says distributions not enough to qualify
as a present interest.
•Differs
from the Hackl case where there were no
distributions


A typical provision that prohibits transfer
without the consent of the general partner
(or Manager) or without the consent of all
partners falls into the Hackl /Price trap
Why not use a right of first refusal—one that
works and no restrictions at all?

Require some distributions?





Not enough per Price for discretionary + actual
Mandatory distributions of net cash flow
Mandatory tax distributions
Distributions may be inadvisable due to 2036 issues
Make donees substitute limited partners not
mere assignees.
 Contrary to maximizing the discount

Use Put rights?

Do NOT use the following language:
“annual or periodic distributions to the
partners are secondary to the partnership’s
primary purpose of achieving a reasonable,
compounded rate or return, on a long-term
basis, with respect to its investments.”

Forego the discount on gift of a partnership
interest when using the annual exclusion—
Use it only on lifetime exclusion gifts
 Give Cash and then
 Let Donees buy interests.
Some taxpayers have taken the position
that the Code Sec. 108(a)(1)(A) bankruptcy
exception is available if a grantor trust or
disregarded entity is under the jurisdiction
of a bankruptcy court, even if its owner is
not.
• Some taxpayers have contended that the
Code Sec. 108(a)(1)(B) insolvency exception
is available to the extent a grantor trust or
disregarded entity is insolvent, even if its
owner is not.
•
The term “taxpayer,” as used in Code Sec. 108(a)(1)
and Code Sec. 108(d)(1) through Code Sec.
108(d)(3), refers to the owner(s) of the grantor
trust or disregarded entity.
Subject to the special rule for partnerships under
Code Sec. 108(d)(6), the insolvency exception is
available only to the extent the owner is insolvent,
and the bankruptcy exception is available only if the
owner of the grantor trust or disregarded entity is
subject to the bankruptcy court's jurisdiction.
Grantor trusts and disregarded entities themselves
will not be considered owners. Prop. Reg. § 1.1089(a)
TEST HERE
OWNER
NOT HERE
DISREGARDED
COD INCOME
In the case of a partnership, the owner rules would
apply at the partner level to the partners of the
partnership to whom the discharge of indebtedness
income is allocable.
If a partnership holds an interest in a grantor trust
or disregarded entity, the applicability of Code Sec.
108(a)(1)(A) and Code Sec. 108(a)(1)(B) to COD
income of the grantor trust or disregarded entity is
tested by looking to the partners to whom the
income is allocable.
TEST HERE
OWNER
NOT HERE
PARTNERSHIP
NOT HERE
DISREGARDED
COD INCOME
If any partner is itself a grantor trust or disregarded
entity, the applicability of Code Sec. 108(a)(1)(A)
and Code Sec. 108(a)(1)(B) is determined by
looking through the grantor trust or disregarded
entity to the ultimate owner(s) of the partner.
TEST HERE
NOT HERE
OWNER
DISREGARDED
NOT HERE
PARTNERSHIP
NOT HERE
DISREGARDED
COD
NO
YES
"Licensed professional counselor" means a person who holds a license
issued under the Texas Occupations Code and who:
(A) represents the person to the public by any title or description of services
incorporating the words "licensed counselor" and offers to provide
professional counseling services to any individual, couple, family, group, or
other entity for compensation, implying that the person offering the
services is licensed and trained, experienced, or expert in counseling; or
(B) engages in any practice of counseling.
THIS SESSION DOES NOT COVER LPCs.
•
DON’T BELIEVE THE PUBLICITY!!!!!
•Eight
states and Puerto Rico have enacted series
LLC statutes that allow an LLC to establish separate
“series” within it.
•The series are not separate legal entities, but each
series has associated with it specified members of
the LLC, as well as specified assets, rights,
obligations, and investment objectives or business
purposes.
•Being
associated with a series is thus comparable to
direct ownership of the series. Under series LLC
statutes, the debts, liabilities and obligations of one
series are generally enforceable only against the
assets of that series and not against assets of other
series or of the series LLC.
MANAGER /PROMOTERS
A
B
As
C
D
Bs
Cs
E
Ds
Es
•§
101.601. Series of Members, Managers, Membership
Interests, or Assets
(a) A company agreement may establish or provide for the
establishment of one or more designated series of members,
managers, membership interests, or assets that:
(1) has separate rights, powers, or duties with respect to
specified property or obligations of the limited liability
company or profits and losses associated with specified
property or obligations; or
(2) has a separate business purpose or investment objective.
•§
101.602. Enforceability of Obligations and Expenses of Series Against
Assets
(a) Notwithstanding any other provision of this chapter or any other
law, but subject to Subsection (b) and any other provision of this
subchapter:
(1) the debts, liabilities, obligations, and expenses incurred, contracted
for, or otherwise existing with respect to a particular series shall be
enforceable against the assets of that series only, and shall not be
enforceable against the assets of the limited liability company generally
or any other series; and
(2) none of the debts, liabilities, obligations, and expenses incurred,
contracted for, or otherwise existing with respect to the limited liability
company generally or any other series shall be enforceable against the
assets of a particular series.
•(b)
Subsection (a) applies only if:
(1) the records maintained for that particular series
account for the assets associated with that series separately
from the other assets of the company or any other series;
(2) the company agreement contains a statement to the
effect of the limitations provided in Subsection (a); and
(3) the company's certificate of formation contains a notice
of the limitations provided in Subsection (a).
•
SO YOU MUST FOLLOW THE FORMALITIES!
§ 101.603. Assets of Series
(a) Assets associated with a series may be held directly or
indirectly, including being held in the name of the series, in
the name of the limited liability company, through a
nominee, or otherwise.
(b) If the records of a series are maintained in a manner so
that the assets of the series can be reasonably identified by
specific listing, category, type, quantity, or computational or
allocational formula or procedure, including a percentage or
share of any assets, or by any other method in which the
identity of the assets can be objectively determined, the
records are considered to satisfy the requirements of Section
101.602(b)(1).
§ 101.606. Liability of Member or Manager for Obligations; Duties
(a) Except as and to the extent the company agreement specifically
provides otherwise, a member or manager associated with a series or a
member or manager of the company is not liable for a debt, obligation,
or liability of a series, including a debt, obligation, or liability under a
judgment, decree, or court order.
(b) The company agreement may expand or restrict any duties,
including fiduciary duties, and related liabilities that a member,
manager, officer, or other person associated with a series has to:
(1) the series or the company;
(2) a member or manager associated with the series; or
(3) a member or manager of the company.
Proposed regulations provide that, for federal
income tax purposes, a domestic series will be
treated as an entity formed under local law, whether
or not local law treats the series as a separate legal
entity. The tax treatment of the series will then be
governed by the check-the-box regulations (Treas.
Reg. §§ 301.7701-1 through 301.7701-3).
So, in a Series LLC, a single state law entity can
actually be multiple entities for federal tax
purposes—each of which has to be separately
classified under the Check the Box Regulations.
So, in a Series LLC, there could theoretically be
one Series that is a partnership for tax purposes
and another that is something different—like a C
corp or S corp depending on how elections are
filed.

INCORPORATED = NO ELECTION AVAILABLE

DOMESTIC DEFAULT CLASSIFICATION FOR
UNINCORPORATED ENTITY IS PASSTHROUGH—

2 OR MORE MEMBERS IS A PARTNERSHIP;

1 MEMBER IS A DISREGARDED ENTITY

FILE FORM 8832 OR 2553 TO ESCAPE DEFAULT

CLASSIFY FOREIGN WHEN RELEVANT

EXISTENCE OR ABSENCE OF PERSONAL LIABILITY
ALTERS DEFAULT CLASSIFICATION FOR FOREIGN
ENTITY
MANAGER /PROMOTERS
P-SHIP
SERIES
A
As
P-SHIP
SERIES
B
Bs
Cs
P-SHIP
SERIES
C
MANAGER /PROMOTERS
P-ship
Series A
As
C Corp
Series B
Bs
S Corp
Series C
Cs
The proposed regulations do not address the entity
status for federal tax purposes of the LLC itself, just
the series within it.
The proposed regulations do not address whether a
series LLC is recognized as a separate entity for
federal tax purposes if it has no assets and engages
in no activities independent of its series.
•Some
jurisdictions have established similar entities known
variously as protected cell companies, segregated account
companies or segregated portfolio companies (cell
companies). A cell company may establish multiple cells,
each of which has its own name and is identified with a
specific participant, but each cell is not treated under local
law as a legal entity distinct from the cell company. The
assets of each cell are statutorily protected from the
creditors of any other cell and from the creditors of the cell
company.
•The
proposed regulations define the term “series” to
include a cell, segregated account or segregated
portfolio that is formed under the insurance code of
a jurisdiction or is engaged in an insurance business
(other than a segregated asset account of a life
insurance company).
•The
IRS will create a new statement that series LLCs and
each series will be required to file annually to provide the
IRS with certain identifying information to ensure the
proper assessment and collection of tax.
•Taxpayers
who currently treat series differently for federal
tax purposes than series are treated under the final
regulations will be required to change their treatment of the
series.
•Dramatic
increase in the use of series LLCs?
Get ready. More states are adopting. Now in Delaware,
Nevada, Utah, Illinois, Iowa, Oklahoma, Tennessee,
Texas and to a limited degree, Wisconsin with more
coming.
•
•Crucial
for state and local taxing authorities to
provide their own guidance regarding whether they
also will treat a series as a separate entity, for both
income taxes and other types of taxes imposed on
the entity.
•Lack
•
of uniformity in state approaches?
Planning opportunities and burdens.
•See
generally M. W. McLoughlin and B. P. Ely, 13
Business Entities No. 1, 14 (January/February 2011).
*and the opinion is not limited to single member
LLCs.
Shaun Olmstead, et al., v. Federal Trade
Commission, 44 So.3d 76 (2010):
A court may order the owner of a single member
LLC to surrender all of his right, title and interest
in the debtor’s single member LLC to satisfy a
judgment.
--Creditor not limited to a charging order despite
the statute that limits the remedy.
W.S. 17-29-503 (2010):
“[The Charging Order] is the exclusive remedy by which a
person seeking to enforce a judgment against a judgment
debtor, including any judgment debtor who may be the sole
member, dissociated member or transferee, may, in the
capacity of the judgment creditor, satisfy the judgment
from the judgment debtor’s transferable interest or from the
assets of the limited liability company.”
“Other remedies, including foreclosure on the
judgment debtor’s limited liability interest and a
court order for directions, accounts and inquiries
that the judgment debtor might have made are not
available to the judgment creditor attempting to
satisfy a judgment out of the judgment debtor’s
interest in the limited liability company and may
not be ordered by the court.”
Wyoming is one of a few states to enact laws allowing
Domestic Asset Protection Trusts—self-settled trusts.
• Thus, with a DAPT as the owner of the LLC units, the
LLC’s income is distributed to the DAPT instead of to a
potentail judgment creditor of the individual.
• The Trustee of the DAPT has discretion to distribute trust
assets to or for the benefit of the beneficiaries of the DAPT,
and the debtor and his family may be one of those
beneficiaries.
•
•
Effectiveness to be determined.
‘‘Tax Extenders Act of 2009’’
ACT SEC. 602. INCOME OF PARTNERS FOR
PERFORMING INVESTMENT MANAGEMENT
SERVICES [including real estate management]
TREATED AS ORDINARY INCOME RECEIVED FOR
PERFORMANCE OF SERVICES.
+
ADD NEW CODE SECTION 710 AND A NEW 40%
PENALTY FOR RELATED UNDERPAYMENTS.
H.R. 436 The Certain Estate Tax Relief
Act of 2009 would have eliminated
most discounts for family limited
partnerships by amending § 2031.
But President Obama
just announced he still
wants to repeal all the
“BushTax Cuts”.
Legislative guidance on receipt of partnership
interests for services. [Proposed Regs. still pending
in absence of legislation.]
Answer: Application of self-employment tax rules
to LLC members.
BUT THEY’VE ONLY HAD SINCE 1988
TO CONSIDER THE ISSUE
And another year bites the dust!
RECALL: Renkemeyer, Campbell, & Weaver LLP