The Incredible LLC Limited Liability Company The Incredible LLC Review Updates Liquidations Texas, the Series At the Beginning The History of the LLC: – First LLC in 1892, German.
Download ReportTranscript The Incredible LLC Limited Liability Company The Incredible LLC Review Updates Liquidations Texas, the Series At the Beginning The History of the LLC: – First LLC in 1892, German.
The Incredible LLC Limited Liability Company The Incredible LLC Review Updates Liquidations Texas, the Series At the Beginning The History of the LLC: – First LLC in 1892, German Company – Established in Germany, spread throughout Europe Page 5 Countries Quickly Adopting LLC Model Portugal Panama Brazil Chile France Cuba Argentina Uruguay 1901 1917 1919 1923 1925 1926 1932 1933 Mexico Belgium Italy Peru Switzerland Columbia Guatemala Costa Rica Honduras 1934 1935 1936 1936 1936 1937 1942 1942 1950 Page 5 Original 5 Basic Characteristics 1. Limited Liability 2. Required use of the word “limited” 3. Could sue or be sued 4. Controlled admission to entity 5. Articles of Organization controlled LLC life Page 6 First State to Create LLC Wyoming in 1977 5 years later, Florida enacted legislation to limit loss on investments. Page 6 History of LLC’s in America March 4, 1977 First LLC Act –Wyoming September 2, 1988 “Kintner” Rules January, 1990 Swift action to create LLC’s by states Page 6 History continued June 7, 1996 51st LLC Act – Hawaii January 1, 1997 Check the Box – 8832 January 13, 1997 Prop. Reg 1.142(a)-2 Page 6 Growth of the LLC LLC’s first were used primarily for: Real Estate Rental and Development Page 7 Types of Businesses Operating as LLC’s Engineering and Mgmt Support 26% Real Estate Services 19% Construction and Gen. Contracting 12% Investment Companies 9% Retailers 8% Other businesses include: Page 7 And Leasing Companies Health Services Agriculture Oil and Gas Restaurants 8% 7% 7% 2% 2% Page 7 Reasons for Popularity 1. 2. 3. 4. 5. 6. Less paperwork and record keeping Pass-through taxation Limited Liability Check-the-box taxation Single or multi-member Assignment of membership interests And…… Pages 7 & 8 More Popularity Reasons 7. Treatment as separate from their members 8. Income retains character to member 9. Presents an alternative to S corporations 10.Multi-member LLC’s may avoid Social Security taxes 11.Single member LLC’s have most simple of business structures Pages 7 & 8 Characteristics of LLC’s Established under state statutes as legal entities. LLC’s can have single members or multiple members. Federal tax classification of LLC is Sole Proprietor, Partnership or Corporation. LLC’s provide full limited liability to their members. Substantial asset protection. Page 8 Practitioner’s Alert Limited Liability Companies do not have limited liability. LLCs can sue and be sued. The Members of the LLC have limited liability. Page 8 Limited Liability To members similar to shareholders Not liable for tort liabilities, debts and other obligations of the LLC Agents and managers not responsible Page 8 In Certain States – Members Liable For debts personally guaranteed All states allow personal guarantee Wrongful acts Amounts promised to be contributed Wrongful distributions Sales tax and trust fund portions Improper personal benefits Violations of criminal laws Malpractice claims Other liabilities in articles of organization Page 9 Personal Liability Members may be liable if LLC is undercapitalized Fails to obtain sufficient insurance to cover risks of business Failure to hold meetings of members or comply with formalities does not Page 9 Practitioner’s Alert Be careful about piercing of the LLC veil and statutory exceptions to the limited liability rule. Because a single-member LLC only has one owner, there may be an increased likelihood that a judge would allow a creditor of the SMLLC to pierce the LLC veil. Page 9 Strengthening SMLLC Protection 1. Maintain formalities of meetings and documents 2. State document record laws 3. Maintain adequate capitalization 4. Do business as the LLC 5. Letterhead, business cards, etc. in name of LLC 6. Use bank account of LLC (not personal) NIT Continued 9. Get EIN, even if not necessary 10. Financial Statements should be LLC 11. Bank loans and forms – LLC 12. Use LLC name in business dealings 13. Have SMLLC operating agreement 14. Follow operating agreement and modify it when needed 15. Utilize proper terminology – Managing Member NIT Special LLC Protection Protection of the asset against creditors Those who obtain judgments against Members Page 11 The Charging Order What is a “charging order?” Who can get a “charging order?” Charging Order Protected Entity - COPE Pages 11 & 12 Creditors & Entities C Corporation – corporate veil S Corporation – involuntary termination Partnership – states protect partners Exception to the Partnership Page 12 Charging Order Protection A creditor must usually follow this path to relief when seeking to obtain assets from a COPE. – Obtain a judgment; – Charge the interest; – Foreclose the charging order; – Appoint a receiver; and – Partition the entity. Page 12 Example Beanna owns 50% of a trucking company – Beanna’s LLC. The LLC has $500,000 in assets Beanna’s involved in a hunting accident A judgment of $5M is against Beanna Creditor wants Court order dissolving LLC and the sale of assets to satisfy judgment Page 12 Example Continued Creditor’s remedies in most states will not allow Creditor receives “charging order” Under Corporate Law, creditor would most likely receive stock and force liquidation for receipt of asset value. Page 12 Practitioner’s Alert Charging orders protect entities and are some of the strongest and most acceptable asset protection tools available. These entities afford a significant degree of protection for the partners or members against any creditor. Page 12 All States Allow Charging Orders Members and debtor retain: Voting rights Power to decide about distributions – when and how much No compelling to make distributions to satisfy debt Page 12 Alert The only right of the creditor is to receive distributions by the LLC to that particular member. Page 12 But, What About SMLLCs Creditor may pierce the LLC veil Must have legal grounds Page 13 Practitioner’s Alert There is an exception to the rule in some states if the LLC is a single-member LLC, meaning the LLC is treated as a disregarded entity. The creditor may attach the assets of the single-member LLC in satisfaction of the judgment. Page 13 Practitioner’s Alert Sole proprietorships and corporations do not provide business asset protection. Page 13 Foreclosure on a Member’s Interest Some states allow foreclosure At sale, purchaser has rights of transferee Judgment debtor has no rights after foreclosure Page 13 Foreclosed Interest May be Redeemed By the judgment debtor With property other than LLC property by one or more of the other members With LLC property by one or more members, with consent of all members whose interests are no so charged Page 13 States that Prohibit Foreclosure Alabama Alaska Arizona Arkansas Connecticut DC Delaware Florida Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri New Hampshire New Jersey Page 13- Update As well as… New Mexico New York North Carolina Ohio Oklahoma Oregon Rhode Island Tennessee Texas Vermont Page 13 Updated Contractual Flexibility The Operating Agreement – Governs LLC operation – Can be changed – No bylaws or minutes required Page 13 & 14 Example J. B. Sims Services, LLC Single Member LLC’s require operating agreements Should be reviewed at least annually by tax professional Page 14 Statutory Informality LLC Acts in most states have very few formal requirements on the formation of the LLC. Check state web sites or www.findlaw.com for requirements Page 14 Management of the LLC 1. Member Managed 2. Manager Managed 3. Corporate Management Default management is by the members. Page 15 Operating Agreement The LLC Operating Agreement determines how the LLC will be managed and by whom. Page 15 Award For Management Flexibility Goes To… Offering the most flexible form of operation is: A. C corporation B. S corporation C. Limited Liability Partnership D. Limited Liability Limited Partnership E. LLC Page 15 Practitioner’s Alert Tax professionals should be aware of potential conflicts of interest in representing both the Managing Member and the LLC before the IRS. If a potential for conflict exists, the tax professional should make every effort to comply with Circular 230 Federal Code of Regulations concerning conflicts of interest. Page 15 Articles of Organization Required by most states. State web sites offer sample “Articles.” Minimum requirements include: – Name and address of entity; – Nature of business; – Name and address of registered agent; and – Names of managers and members. Pages 15 & 16 Sample: Articles of Organization Note: Not Articles of Incorporation Sample on Page 16 of text. Refer to individual state web sites for requirements or to www.findlaw.com Page 16 LLC Tax Classification At formation, the Limited Liability Company is a: “tax nothing!” NIT Federal Tax Classification Sole Proprietor Partnership Corporation – C corporation – S corporation Page 17 Practitioner’s Alert The instructions for Form 1065 for 2011, page 3, state “A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. Unlike a partnership, none of the members of an LLC are personally liable for its debts. Page 17 Entity Classification – Form 8832 Incorporating vs. LLC formation Incorporation C Corporation S Corporation Page 17 Federal Tax Classification Defaults Elections What is the difference? The LLC is the most flexible vehicle for operating a business. Page 17 Practitioner’s Alert Tax professionals should review the LLC operating agreement on at least an annual basis and more frequently if there are changes of note. If the operating agreement indicates that the federal tax classification for the LLC has changed since the last tax filing, a Form 8832 should be part of the filing. Page 18 Automatic Classification as a Corporation Business organized as corporation; An Association; Joint-stock Company or Association; Insurance Company; Federally insured state-chartered bank; Business owned by state or political subdivision of state; Publically traded business as a corporation; and Certain foreign business entities. Page 18 Limited Liability Company §721 Sole Proprietorship Form 1040 Schedules C, E or F C Corporation Form 1120 Partnership Form 1065 S Corporation Form 1120 S Form 2553 Defaults Elections Page 18 Practitioner’s Alert 60 month waiting period: – Election after formation – 60 month waiting period not required if election initially made Page 19 Form 8832 When do you use Form 8832? When the LLC wishes to make an “election”. When the LLC wants to change its previous classification. When the LLC has some doubt as to the proper classification. Page 19 Form 8832 Instructions www.irs.gov Pages 20 - 26 Let’s Look At the Form AND Instructions Page 20 (Page 1 of Form 8832) Line 1 – Type of Election a. Initial b. Change Line 2 a– Previously filed an election within 60 months Yes No Page 20 Form Tells Us Line 2b – Was election effective at formation? Yes No Line 3 & 4 – Requests information if LLC is a SMLLC and information about owner. Page 20 Page 2 of Form 8832 Page 21 of Text. Line 6 – Type of Entity a-f Domestic and Foreign – Corporation, Partnership or SM Line 7 – Question re: Foreign LLC Page 21 Finally on Page 2 Line 8 – Date of Election (Notice NO default) Line 9 – Name and title of contact person and telephone number Signature Page 21 Seldom Seen, Seldom Read Instructions Page 22 of Text (Page 3-6 of Form 8832) Default classification – NO Form 8832 Page 23 of Text When to file Form 8832 – 75 days Late relief - *See new procedure later Where to file – based on entity’s principal business, office or agency location Pages 22 & 23 Seldom Seen, Seldom Read Instructions Election acceptance by IRS: IRS Service Center will notify Care exercised to “make certain 8832 received by IRS Certified mail receipt 8832 with accepted stamp 8832 with stamped IRS received date or IRS acceptance letter Page 24 More Instructions Page 24 of Text, Page 5 of Instructions: 60 month limitation rule. Note: The 60-month limitation does not apply if the previous election was made by a newly formed eligible entity and was effective the date of formation. Page 24 Specific Instructions Page 25 of text – 6 of instructions Part II. Late Election Relief - **later** Page 25 Final Instructions Page 26 of Text. Page 7 of Instructions. List of Foreign LLCs taxed as Corporations in US Note: Domestic LLCs taxed as SMLLCs or Partnerships may be taxed as Corporations in other countries. Page 26 Late Elections - NEW Rev. Proc. 2009-41, 2009-39 IRB Provides relief to eligible entities seeking late elections: File within 3 years and 75 days of effective date Guidance also for non-qualifying Page 27 What is Covered? Acknowledgement of “check the box” regulations Form 8832 Effective date may NOT be more than 75 days before date on which election is filed and NOT more than 12 months after the date election filed. If more time requested, 12 months after election filed is effective date. Pages 28 & 29 Rev. Proc. 2002-50, 2002-2 CB 615 Now Superseded Rev. Proc. 2009-41 liberalizes 2002-50 Section 3.01 extends late entity classification to both initial classification elections and changes in classification elections Will this affect the 60-month rule? Pages 28 & 29 Rev. Proc. 2009-41 Extended time for filing to within 3 years and 75 days of requested effective date. More liberalized than 2002-59 Use in lieu of letter ruling for late entity election Pages 28 & 29 Qualifying Rev. Proc. 2009-41 Requests, solely, no initial or change in federal tax classification, Form 8832, filed Either, due date, excluding extensions, of return not passed or All returns filed were as if election were in effect. Reasonable cause 3 years and 75 days have not passed Pages 28 & 29 How to Get Relief Within 3 years and 75 days file Form 8832 with applicable Service Center At top “Filed Pursuant to Rev Proc 200941, including declaration of meeting requirements and reasonable cause statement. A statement with declaration, signed under penalties of perjury by authorized person. IRS will notify Pages 28 & 29 Private Letter Ruling Entities not eligible for 2009-41 PLR – request must include: – Why 2009-41 does not apply – All returns filed (including information) or none required – Filed timely or within 6 months, excluding extension, with federal tax classification desired – No returns filed inconsistent with the desired classification Pages 28 & 29 Effective Date September 28, 2009 Applicable to pending requests PLR may be withdrawn in light of 2009-41 prior to 11/12/98 User fee refunded Pages 28 & 29 Federal Identification Number A. Existing Sole Proprietors and Partnerships – no requirement for new EIN if one is currently being used. B. LLC’s electing to be taxed as Corporations must apply for new EIN. C. Sole Proprietor’s without EIN must apply. Page 29 Let’s Talk Need for EIN Very existence Separate individual owner from business Do not impose liability NIT SS-4 Application for Employer Identification Number Electronic version www.irs.gov Pages 30 - 31 Pages 30 - 31 SS-4, Page 1 Line 8a – Is this an application for a LLC or foreign equivalent. Line 8b – If YES, enter number of LLC members Line 8c – Was LLC organized in the United States (YES or NO) Page 30 SS-4, Page 1 Line 9a – Type of Entity SMLLC (Schedule C, E, F) DO NOT use first box or enter your Social Security Number. Partnership Corporation Form 1120 or Form 1120S Other – Disregarded Entity (DRE) Sole Proprietor Page 30 SS-4, Page 1 Line 18 – Has applicant shown on line 1 ever applied for and received an EIN? Do not answer this question based upon the individual member – the question is about the entity applying for the EIN. Page 30 SS-4, Page 2 Do I Need an EIN? Used for Federal identification purposes Is there another need for an EIN? Page 31 Cautions LLC’s are required to have own EIN S Corporation status is obtained by filing Form 2553. DO NOT FILE FORM 8832 Be careful when “converting” to an LLC and using existing EIN Page 31 Example Beanna, Marilyn and Tom Taxation with Representation, LLC Pages 31-34 Pages 31-34 Social Security and Self-Employment Tax Proposed Regulations, Section 1402(a)(13) – January 13, 1997 – Apply to all entities classified as partnerships – Bifurcation is allowed Page 34 Guaranteed Payments General Partners – Guaranteed payments – Subject to SE tax Page 34 Practitioner’s Alert All guaranteed payments are fully subject to self-employment tax. Page 34 General Partners LLC members actively engaging in the business are treated as GPs for SET purposes. Distributive shares of income from the LLC are net earnings from SET unless bifurcation is allowed. Page 34 Practitioner’s Alert LLC Members who are passive investors and who are not managers of the LLC should not be subject to selfemployment taxes on their distributive share of income. This should be stated in the operating agreement. Page 34 Section 1.1402(a)(13) Remains proposed Under proposed regulation member (partner) may exclude some or all of the income for SE earnings if any of the following exist: – Member is limited; – Member owns more than one class; and – Member bifurcates between SE and nonearnings from SE Page 35 Practitioner’s Alert Self-employment taxes are not an issue if none of the members is an individual. Page 35 Example Tom, Beanna and Marilyn each have own LLC. LLCs own interests in Taxation with Representation, LLC Only individuals pay SET. Page 35 Proposed Regulation 1.1402(a)(13) Definition of a limited partner: 1. Member has no personal liability, 2. Member lacks authority to sign on behalf of LLC, 3. Member works for the LLC for 500 or fewer hours in the year. Must meet all three! Page 35 Exclusion of SE Tax Under regulations, the member may exclude some or all of the income from self-employment earnings if any of the following conditions exist: – Member is limited; – Member owns more than one class of membership interest; or – Member bifurcates interest. Page 35 More Than One Class of Interest Member, not a limited partner, may exclude from SE earnings a portion of the distributive share if they own more than one class of membership interest. Operating Agreement must provide for at least two classes of interests. Page 36 Result Members may divide interest between SE income and non-SE income. Member will be treated as a limited partner and be exempt from SE taxes with respect to one of the classes of membership interests if: Page 36 Requirements Limited partners own a substantial, continuing interest in the same class of membership interest, and The rights and obligations with respect to that class are identical to other members who hold that class of interest. Page 36 Professional’s Alert Ownership of 20 percent or more of the class is substantial. Page 36 Practitioner’s Alert When both are met, even persons who are active as partners will be treated as a Section 1402(a)(13) limited partner with respect to their distributive shares of partnership, LLC, income in respect to each investment class in which they own an interest. Page 36 Practitioner’s Alert The multiple class exception can be applied to an LLC provided the LLC operating agreement is properly drafted to create specific classes of ownership interests. Page 36 Sample Operating Agreement Two Classes of Interest required Investor Class and Managerial Class Must allow for bifurcation 20 percent Investor Class always issued and outstanding Pages 36 - 38 Professional Services Health Architecture Law Accounting Engineering Actuarial Science Consulting *Providing services Page 38 What Can Be Done! Tom, Marilyn and Beanna form Taxation with Representation, LLC. Another LLC is formed as well. Each contributes furniture, equipment and books to You Rent from Us, LLC Taxation with Representation , LLC rents from You Rent from Us, LLC Pages 38 & 39 Results You Rent from Us, LLC uses newer regs to exclude all of distributive shares of selfemployment tax. Taxation with Representation, LLC has deduction for rent. Tom, Marilyn and Beanna have income from You Rent from Us, LLC, not subject to SET. Page 39 Another Strategy For SMLLCs – Schedule C or F Contribute depreciated or near complete depreciation assets to a new LLC with a partner. Schedule C or F now rents from LLC, creating a deduction for FIT/State and SET NIT Part II. Disadvantages of the LLC include: Franchise Tax Levied by States: – Alabama, – California, – – – – – Kentucky, New York, Pennsylvania, Tennessee, and Texas Page 45 Practitioner’s Alert $300 for formation of LLC in Texas $ 25 additional fee for expediting 6/3/11, $1M exclusion of Franchise Tax extended beyond 12/31/11 to 12/31/13 12/31/13 exclusion is $600,000 Page 39 Disadvantages, continued Difficult to raise financial capital. LLC is relatively new. No statutory requirement for an operating agreement but members may have problems if operating without one. Some people are unfamiliar with LLC’s. Different titles than corporate managers. Taxing jurisdictions outside the U.S. Pages 39 & 40 Creditors require co-signature on debts. State and federal filing requirements include: – Tax return for the LLC, – Tax returns for the resident or nonresident members, and – The annual report for the LLC. Page 40 Too Many LLC’s Need: To separate assets into multiple LLC’s to limit liability exposure. Delaware series LLC – Cells – Container Page 41 Overview Single LLC divided into separate divisions for liability purposes. States with “series” LLCs include: Delaware Oklahoma Wisconsin Illinois Tennessee North Dakota Iowa Texas Minnesota Nevada Utah Puerto Rico Page 41 Characteristics Delaware was first state to enact the “series” LLC and is most often the formation location Allows one LLC for a series of operations for separate liability purposes Debts and obligations of one will not impact the others in the series Page 41 Specifics Each series may have different: – Members – Managers – Businesses – Ownership percentages Distributions in one series may be without regard to other series Page 41 To Avoid Too Many LLCs…. Charging Order continues to protect Separate assets with great liability from less liable assets created multiple LLCs Often created multiple LLCs with costs associated. Page 41 The Series Separate Cells within container Each series with different members, managers with separate rights and duties Each treated separately for assets and accounting Public notice must be made – Certificate of Formation Page 41 Key Reasons to Use Saves substantial organizational costs Remember Texas $300 fee Typically used by holders of real estate One single LLC and a series for each of the real estate parcels Page 41 Relief from the Series Not 3 separate LLCs, but one (series) Liability of one property does not extend to other properties Texas – Part IV Page 42 Procedures to Form Certificate of Organization filed in state allowing “series” LLC Certificate states “series” exists and no connection through liability to each Operating Agreement must establish each series, designate members and managers of each and property placed in the series NIT Continued Must qualify to do business in the state(s) Absent statute, mere acquisition of real property does not require qualification Fictitious name for each series must be filed, ie. XYZ, LLC, each series XYZ, LLC – Series 1000 Main Street NIT Real Property Transfers LLC owns the property in each series Assets within the series must segregate their properties Property must be transferred to the fictitious name (dba) NIT More Requirements Separate bank account for each series Separate accounting for each series State filings for each state in which business is conducted AND Separate return for each series in the state NIT For Federal Tax Purposes Either: 1. Single return filed for each in the series – special allocations allowed. 2. Separate return filed for each in the series – based on IRS rulings and court cases NIT Segregating Assets Separate dangerous assets from safe assets Gas station from rental home Cash assets in business with operational business Separate every distinct entity but under one series LLC NIT Summary of the Series Series has own separate purpose Can be terminated separately from series Makes distributions without regard to others Debts of one not applied to others in series NIT To Do It Each in series is treated separately Books and records kept for each in series Assets in each held and accounted for separately In order that the Public know it is series LLC, inclusion with Secretary of State a notice is required NIT Key Reasons to Use Saves substantial organization costs Used by taxpayer with multiple parcels of land One single LLC holds all series of parcels NIT Example Beanna has 3 rental properties Commercial worth $1M, apartment complex worth $750,000 & residence worth $100,000 Renter sues successfully – court could award all LLC property Before Delaware series LLC, Beanna would have to form 3 separate LLCs. Page 42 Part III Improper formation of the LLC: Failure to meet the taxpayer needs. Page 42 LLC Is Not the Proper Formation Business operates crossing multiple state jurisdictions. Costs are prohibitive – Insurance Vs. LLC. Membership interest in an LLC may not be Publically traded. Automatic dissolution. Page 43 Failure to Make an Election Form 8832 not filed. Rev. Proc. 2009-41 3 years and 75 days Page 43 S Election – Form 2553 Failure to timely file Form 2553 may create additional problems for the LLC and its members. Page 43 Mergers and Conversions Gone Bad Procedures to follow are exact. Failure to follow procedures may result in undesired tax position. Page 43 Example Beanna is sole shareholder of Taxation with Representation, Inc. not acting as a corporation The “F” reorganization – Name Change Only Exact procedures to be followed Failure results in unfavorable tax consequence Page 43 Only Question Does attorney have errors and omissions insurance? Procedures must be exact. “F” reorganizations are simple name changes and should not result in any taxable exchanges. Page 43 Littriello v. U.S. Taxpayer challenged validity of check-thebox IRS believed Littriello responsible for payroll taxes of SMLLC Page 44 Background Check-the-box allows tax classification unless classification required Multi-owner LLCs can be corporations or partnerships Single members may elect to be taxed as corporations or DREs Page 44 However A single-member not electing to be taxed as a corporation is considered a DRE for federal tax purposes Then activities are treated the same as sole proprietor Page 44 Case Facts Littriello – sole member of several Kentucky LLCs Made no election – filed Schedule C LLCs did not pay payroll taxes IRS notified of intent to levy Littriello went to court Page 44 Court Decision Littriello argued regs were invalid exercise of authority Regs would be unenforceable and IRS could only go after the LLC, not Littriello The district court rejected his argument and found regs valid Page 45 Practitioner’s Alert Court rejected contention that IRS must recognize separate LLC, matter of state law Court acknowledged but said, Littriello’s SMLLC entitled to what state would give but…. Page 45 …state law could not eliminate his federal tax liability Page 45 Contradiction Rev. Rul. 2004-41, 2004-18 IRB 845 IRS may not collect LLCs unpaid employment tax from LLC members in a multi-member LLC Only as responsible persons under IRC 6672 – trust fund penalty Page 45 Liability for Employment Tax January 1, 2009, SMLLC are treated as corporations for employment purposes LLC is liable Must file under own name and EIN – watch conversions Taxes deducted on Schedule C Page 45 Where are We NOW Regs now treat Single-Owner DREs as separate entities for employment taxes and reporting Owners of DREs no longer liable for employment taxes Pages 45 & 46 Practitioner’s Alert The final regulations take care of the Littriello-type cases involving unpaid employment taxes. However, the LLC member may be liable for the unpaid employment taxes under the Code Section 6672 – trust fund penalty tax rules. Page 46 Members Not Liable Rev. Rul. 2004-41 - 2004-18 IRS may not collect LLCs unpaid employment taxes from members They are not liable Even if taxed as a partnership obligated under state law Page 46 Professional’s Alert However, the LLC members may be liable for the unpaid employment taxes under the Code Section 6672 trust fund penalty tax rules Page 46 Multi-Member Domestic LLC Default to partnership taxation State law provides joint and severable liability for partnership obligations IRS may seek to collect federal tax liabilities incurred by partnership from general partners However, multi-members of an LLC generally are not liable under state laws for entity’s debts – some limitations Page 48 Assessment Extends to General Partner U.S. v. Galletti Reverses Ninth Circuit Said partnership was taxpayer and general partners are liable General partners are liable for LLCs liability Page 48 Part IV. Liquidating Federal Tax Classifications And Maintain the LLC Page 48 Limited Liability Company Understanding Liquidation Sole Proprietorship Form 1040 Schedules C, E or F C Corporation Form 1120 Partnership Form 1065 S Corporation Form 1120 S Form 2553 NIT Liquidating the Federal Tax Classification Sole Proprietorship Class of Assets Agreed to in writing Form 8594, Asset Acquisition Statement Page 48 Residual Method Purchase price is allocated in order: Class I - Cash and cash equivalents Class II - CDs, Gov’t Sec., stock, etc. Class III – Mark-to-market assets certain debt instruments Class IV – Stock in trade; inventory Class V - All other assets Class VI - Section 197 intangibles Class VII – Goodwill and going concern value Page 49 Agreement Buyer and seller may agree in writing to allocations Allocations are binding on both parties § 1060(a) Page 49 Practitioner’s Alert Generally, the purchaser and the seller must both file Form 8594, Asset Acquisition Statement to report the sale of assets used in a trade or business when the purchaser’s basis in the assets is determined wholly by the amount paid. The forms are attached to the tax returns for the year in which the sale took place. Page 49 Partnership Code Sec. 731(b)(1) No gain or loss recognized unless distribution in cash exceeds adjusted basis of partner’s interest in partnership immediately before the distribution. Page 49 Income Recognition to Partner Loss not recognized unless distribution in liquidation No other property than cash and securities distributed, loss is recognized (excess of basis of partner’s interest over sum of any money distributed and any unrealized receivables and inventory) § 751(c) & (d) Page 50 Income Recognition to Partner If distribution of money exceeds partner’s basis, gain is recognized as if he had sold his partnership interest. § 731(a) Applies to both liquidating and nonliquidating distributions. Reg. § 1.731-1(a) Page 50 Example Jean purchases a partnership interest for $100,000. First year Jean receives cash distribution of $100,000 and property with FMV of $30,000. No gain recognized since money distributed does not exceed Jean’s basis for partnership interest $100,000. Page 50 But if. . . Had she received a cash distribution of $130,000, a $30,000 gain would have been recognized. Cash distribution must “exceed” partner’s basis Page 50 Practitioner’s Alert Where gain is determined by reference to money and marketable securities, the securities are valued at their fair market value on the date of the distribution. Distributions of property encumbered by a liability may cause a partner’s share of partnership liabilities to decrease, resulting in a “deemed distribution” of money to that partner. Page 50 Loss Recognition Recognized only if distribution terminates partner’s interest but only if distribution is money, unrealized receivables, or inventory Loss is excess of basis over sum of money distributed to partner. § 731(a)(2) Page 50 Example Jean has basis in partnership of $100,000 retires She receives $50,000 in cash and inventory having a basis to partnership of $30,000. Jean has a capital loss of $20,000 Page 51 Basis of Property Received In distribution, other than liquidation of a partner’s interest, basis to partner is same as partnerships basis prior to distribution Basis of property in the hands of the distributee may not exceed the basis of his/her partnership interest reduced by amount of money distributed in transaction Pages 51 Example Jean has a basis of $100,000 in her partnership interest Receives a non-liquidating distribution of $40,000 in cash and property with a basis to the partnership of $80,000 The basis to Jean of the property is $60,000 ($100,000 - $40,000) Page 51 What Happens to the $20,000? Partnership recovers the $20,000 by making an election § § 734, 754, and 755 allow the adjustment of the remaining partnership assets Page 51 Corporations Distributions in liquidation – deemed sale Section 336(a) – Corporation recognizes gain or loss and distribution to shareholders/members Conversion from Corporation to another FTC can result in tax consequences Page 51 Corporate Distributions and Dissolutions Result: Double Taxation NIT S Corporations Follows liquidation of Corporation rules Distributions treated as sales Gain recognized (property’s FMV exceeds basis) Page 51 Example Jean is a single-member LLC taxed as an S corporation Jean, LLC has land with an adjusted basis of $50,000 held for 2 years as an investment At the beginning of the year, Jean, LLCs AAA has a balance of zero and Jean’s basis in the LLC was $72,000. Page 52 Example Continued LLC has net income for year of $41,000. S Corp distributes land to Jean At distribution, FMV of land is $60,000 What happens? Page 52 Well… LLC recognizes $10,000 of long-term capital gain ($60,000 FMV less $50,000 basis), and passes through to Jean on her K-1 Jean has $41,000 of ordinary income from S corporation operations for the year Jean’s basis before considering distributions is $123,000 ($72,000 + $41,000 + $10,000) Page 52 And. . . Jean’s basis in the land after the distribution is FMV, $60,000. Jean’s stock basis after the distribution is $63,000 ($123,000 - $60,000), $9,000 less than at the beginning of the year. The LLC AAA is increased by $51,000 and then reduced to zero. Jean’s equity account is reduced by $9,000 ($60,000 less the $51,000 distributed out of AAA). Page 52 Result Property distributions are generally treated as though the corporation sold the property to the shareholder for FMV. If the property’s adjusted basis exceeds its FMV, loss generally is not recognized. Page 52 Practitioner’s Alert Because the loss on property distributed when its basis exceeds its FMV is unrecognized, and because stock basis and AAA may be reduced by the unrecognized loss, distributions of such property should be avoided. Page 53 Other Items Loss can be recognized in liquidation of S Corporation In liquidation, distributed property is a deemed sale at FMV by S Corporation Gain or loss flows through to shareholders under pass-through rules So….. Page 53 Liquidating an S Corporation Does not recognize corporate-level tax unless § 1374 BIG rules apply Rules apply when former C Corp and FMV of asset exceeds basis of corporation at beginning of corporations first taxable year as S Corporation Page 53 Practitioner’s Alert A shareholder who receives a property distribution is required to fulfill a holding period that begins when the shareholder actually receives the property. This requirement is in place because the property distribution is treated as if the property were sold to the shareholder at its FMV on that date. No carryover basis so no carryover holding period. Page 53 Practitioner’s Alert 2 Liquidation of S Corporation vs. C Corporation is similar. Both have double taxation S Corporation: result is additional basis to shareholder Page 53 Liquidating the LLC Based upon the federal tax classification of the LLC the liquidation process complete, the following items remain: – Filing of final federal tax return – Filing of final state income tax return, if applicable – Filing of state dissolution - Franchise Page 53 Caution Liquidation of each Federal Tax Classification, inside or outside of a Limited Liability Company, is a complex and transaction and warrants the research of specific Revenue Rulings, Revenue Procedures and the Internal Revenue Code. Specific Tax Court cases should be reviewed prior to proceeding. Page 53 Part V. Texas - Series September 1, 2009, S.B 1442 – establishes Texas Series LLC Series LLC establishes multiple series of assets, members and managers Debts and obligations of a series only enforceable against the series Not against other series in the LLC or against LLC generally Page 54 The Series LLC Members in a series can be given separate rights and duties within series Separation of assets and partitioning of liabilities in one LLC can avoid many of the inefficiencies and costs associated with multiple LLCs Page 54 Example Series LLC holds multiple parcels of real estate Each is a separate series All in one LLC Page 54 Texas Statute Similar to Delaware Both authorize LLCs operating agreement to establish one or more series Both provide the liabilities of a series are enforceable only against the assets of the series Not against the LLC generally Page 54 Specific Rules a) Records of series account for assets separately form assets of other series b) Operating agreement states liability limitations c) Certificate of formation gives notice of limitations on liability Page 54 Each Series May… Sue Be sued Contract Hold title to real estate and personal property Page 54 Series LLCs New, useful, legal uncertainties Taxation, bankruptcy & doing business in multiple states Tax Questions – IRS – PLR in 2008 clarified each series would be determined independently for tax purposes Page 55 Bankruptcy Unclear in federal bankruptcy court Could ignore the series and consider entire LLC Result may depend on relevant state law Page 55 Practitioner’s Alert 8 states now have “series” LLCs 42 states have no provisions for “series” Will non-series states honor structure and liability shield? Can “series” state formations file in “non-series” states to transact business? Page 55 Series LLCs Law is infant in stage, unsteady on feet LLC at one time was infant with initial uncertainties and thought to have risk From Wyoming in 1977 to 51 LLC acts Most popular form of new business Page 55 History Predicts series LLCs will be come routinely used Page 55 Texas Franchise Tax Update 1/3/12 Frequently Asked Questions Not general partnership #3 LLC – yes – even when taxed as general partnership #4 DRE – yes #13 (nexus in Texas) Pages 56 & 57 #19. Series LLC Franchise – taxed as single legal entity Pays one filing fee and registers as ONE entity with Texas Secretary of State Files ONE Franchise Report, not as combined group If ONE series has nexus in Texas, entire LLC has nexus – added 9/9/11 Page 58 Part VI. Your client, Joe the Plumber Announces formation of an on-line LLC He has a W-2 and taxes withheld You ask Joe for a copy of the Operating Agreement and Form 8832 None What can you do? What should you do? Page 58 Joe the Plumber Formed an LLC, on line Has W-2 Knows you are sooooooo Proud Page 58 No Form 8832 Filed What can you do? What should you do? Page 58 Joe Wants to Add Partner Wants to keep LLC What does LLC need to do? What are options of the LLC? Page 58 New Partner Doesn’t Work Out Wants to leave partnership What happens to the LLC partnership? What would happen if LLC was taxed as C Corporation? Page 58 Problem Husband and wife LLC – operation 2 years Owns property - $100,000 basis and FMV of $1M Form 1120 file in 2010 – no record of Form 8832 being filed – no operating agreement What do you do? Page 58 LLC Taxed as C Corp Not initial election – in 30th month Members no longer want to be taxed as C Corp – buying real estate they want to avoid double taxation Is LLC required to be C Corp 60 months before changing election? Is there any other way they can terminate C Corp classification? Page 59 George wants Russian Brother to Become Member of LLC Can he be a member and be an “alien”? What federal tax classifications can the LLC have if “alien” brother becomes a member? Page 59 P a LLC is Formed as Partnership Two members One withdraws – what happens? What elections can remaining member have? Will LLC have to get new EIN? Page 59 George wants LLC to be Taxed as C Corporation You fail to make Form 8832 Election Under Revenue Procedure 2009-41, how long do you have to file a late election? Page 59 LLC and SET Form LLC for tax business Multimember All members pay SET on distributable share of income What election can you make to avoid partial SE tax and avoid PSC tax? Page 59 New Client Wants to go into business Recommend how to form the business Wants to protect his personal assets What form do you recommend? Page 60 Part VII. – The Test! 1. Sole Proprietorship Owners are referred to as a: ____________, but not as a ____________. 2. Partnership Owners are referred to as a : ___________, but not as a _________. 3. Filing 1120, the Owner is referred to as a : __________, but not as a __________. Page 60 Test 4. Filing 1120S, the Owner referred to as a: _________, but not as a ___________. 5. As you change the federal tax classification of the LLC, do you need a new federal identification number? 6. What is the automatic default? Pages 60 More Test 7. If LLCs are not in the Tax Code, how would you do your tax research for each one of the four federal tax classifications? 8. Define a disregarded entity, sometimes referred to as a DRE. 9. Can an LLC be taxed as a C corp or an S corp without incorporating? Pages 60 A Few More 10. As a member, what is my role in the LLC? a. Will you receive a certificate of ownership? b. Will you be able to vote according to the number of units owned? Pages 60-61 Almost Done c. Is there a limitation on the number of members the LLC may have? e. Form 8832 is used in what three circumstances? f. What two federal tax classifications can be obtained by the LLC with no election? Page 61 Really Close Now g. Can an election be made any time during the tax year to change from a sole proprietorship or partnership taxation to corporate taxation? h. If the taxpayer elects out of the default classification, does this constitute an election for the 60-month rule? Page 61 I See the Finish i. When does the LLC make an election that does not require they stay the election for 60 months? j. What IRS Form is filed to elect the LLC to be taxed as an S Corporation? Page 61 Finished! k. What entity allows a business to change its taxable status as it needs, wishes and desires for the business change, with minimal effort? Page 61 Part VIII – Why LLC? Best attributes of the four entities No personal assets of owners subject to creditors Limited liability without incorporating LLCs are attractive alternatives Page 61 Practitioner’s Alert A Florida Supreme Court Ruling – June 24, 2010 Single member LLCs no longer provide asset protection from claims made by creditors of the LLC owner. Florida! NIT Why NOT be an LLC? State tax considerations States not uniform Different fees and rules Page 62 Ways to Use SMLLCs Asset protection for Schedule C Taxpayer Schedule E Rental Property For noncorporate subsidiaries of C Corps. For noncorporate subsidiaries of S Corps For noncorporate subsidiaries of FLP 1031 Exchange 1033 Replacements Page 62 Maintaining Limited Liability Maintain formalities Document compliance Adequate capitalization LLC does business Use of LLC name Separate bank account File returns & reports SMLLCs use LLC name Get tax ID number Prepare LLC Financial Statements Applications for Loans in LLC name Use LLC name Have Operating Agmt. Page 62 LLCs Limited Liability Companies (LLCs) have provided the tool that business owners have long desired: Business simplicity with limited liability. Page 63 It’s Up to YOU! Knowledgeable, informed tax professionals, knowing the needs, wishes and desires of their clients, will determine if the LLC is the correct form of business and select the federal tax classification which most uniquely meets the needs of their clients. Page 63