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LLC and Limited Partnership Update. 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.

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llc and limited partnership update

LLC and Limited Partnership Update

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.”

slide2

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

ccdavis@kjllp.com

circular 230 disclosure

CIRCULAR 230 DISCLOSURE

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.

slide5

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.

no says the tax court
NO says the Tax Court
  • 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.
slide7

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.
impact
Impact
  • 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!

annual gift exemption case price v commissioner

ANNUAL GIFT EXEMPTION case: Price v. Commissioner

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.

slide10

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

so what do we do no perfect solutions to price
SO WHAT DO WE DO?NO PERFECT SOLUTIONS TO PRICE
  • 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?
slide12

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?
slide13

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.
slide14

New Prop. Regs. On §108 c.o.d. bankruptcy and insolvency exceptions AS applied to disregarded entities ISSUED 4/12/11

slide15

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.

proposed regs 4 12 11

Proposed regs. [4/12/11]

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 1 108 9 a
Grantor trusts and disregarded entities themselves will not be considered owners. Prop. Reg. § 1.108-9(a)
slide18

OWNER

TEST HERE

DISREGARDED

NOT HERE

COD INCOME

slide19

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.

partnership

TEST HERE

OWNER

NOT HERE

PARTNERSHIP

DISREGARDED

NOT HERE

COD INCOME

slide21

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.

partnership1

TEST HERE

OWNER

DISREGARDED

NOT HERE

PARTNERSHIP

NOT HERE

DISREGARDED

COD

NOT HERE

lpc licensed professional counselor

LPC = LICENSED PROFESSIONAL COUNSELOR

"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!!!!!

series llc

SERIES LLC

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.

series llc1

SERIES LLC

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.

series llc2

SERIES llc

MANAGER /PROMOTERS As Bs Cs Ds Es

A

B

C

D

E

slide30

tboc

§ 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.

slide31

Tboc

§ 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.

slide32

Tboc

(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!

slide33

§ 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).

slide34

§ 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.

irs position

IRS POSITION

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).

slide36

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.

check the box review
CHECK THE BOX REVIEW
  • 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
series llc3

SERIES llc

MANAGER /PROMOTERS As Bs Cs

P-SHIP SERIES A

P-SHIP SERIESB

P-SHIP SERIESC

series llc4

SERIES llc

MANAGER /PROMOTERS As Bs Cs

P-ship Series A

S Corp

Series C

C Corp Series B

what about the state law entity the llc

WHAT ABOUT THE STATE LAW ENTITY—THE LLC?

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.

protected cell companies

PROTECTED CELL COMPANIES

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.

protected cell companies1

PROTECTED CELL COMPANIES

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 future1

THE FUTURE

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.

the future2

THE FUTURE

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.

to learn more

TO LEARN More:

See generally M. W. McLoughlin and B. P. Ely, 13 Business Entities No. 1, 14 (January/February 2011).

florida pierces the single member llc

FLORIDA PIERCES THE SINGLE MEMBER LLC*

*and the opinion is not limited to single member LLCs.

slide48

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.

enter wyoming

Enter wyoming

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.”

enter wyoming1

Enter wyoming

“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.”

cowboy cocktail

“Cowboy Cocktail”

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.

slide53

‘‘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.

slide54

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”.

maybe not dead yet

Maybe not dead yet?

Legislative guidance on receipt of partnership interests for services. [Proposed Regs. still pending in absence of legislation.]

on what topic is there still no legislative thought

On what topic is there still no legislative thought?

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