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The IncredibleLLC
Limited LiabilityCompany
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 1901Panama 1917Brazil 1919Chile 1923France 1925Cuba 1926Argentina 1932Uruguay 1933
Mexico 1934Belgium 1935Italy 1936Peru 1936Switzerland 1936Columbia 1937Guatemala 1942Costa Rica 1942Honduras 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 8%
Health Services 7%
Agriculture 7%
Oil and Gas 2%
Restaurants 2%
Page 7
Reasons for Popularity
1. Less paperwork and record keeping2. Pass-through taxation3. Limited Liability4. Check-the-box taxation5. Single or multi-member6. Assignment of membership interests
And……
Pages 7 & 8
More Popularity Reasons
7. Treatment as separate from their members8. Income retains character to member9. Presents an alternative to S corporations10.Multi-member LLC’s may avoid Social Security taxes11.Single member LLC’s have most
simple of business structuresPages 7 & 8
Characteristics of LLC’sEstablished 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 guaranteeWrongful actsAmounts promised to be contributedWrongful distributionsSales tax and trust fund portionsImproper personal benefitsViolations of criminal lawsMalpractice claimsOther 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 documents2. State document record laws3. Maintain adequate capitalization4. Do business as the LLC5. Letterhead, business cards, etc. in name of LLC6. Use bank account of LLC (not personal)
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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
AlabamaAlaskaArizonaArkansasConnecticutDCDelawareFloridaIndianaIowaKansas
KentuckyLouisianaMaineMarylandMassachusettsMichiganMinnesotaMississippiMissouriNew HampshireNew 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!”
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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; andCertain foreign business entities.
Page 18
Limited Liability Company§721
Sole ProprietorshipForm 1040Schedules C, E or F
C CorporationForm 1120
PartnershipForm 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
Let’s Look At the Form ANDInstructions
Page 20 (Page 1 of Form 8832)
Line 1 – Type of Electiona. Initialb. 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 ReadInstructions
Page 22 of Text (Page 3-6 of Form 8832)Default classification – NO Form 8832
Page 23 of TextWhen to file Form 8832 – 75 daysLate relief - *See new procedure laterWhere to file – based on entity’s principal business, office or agency location
Pages 22 & 23
Seldom Seen, Seldom ReadInstructions
Election acceptance by IRS:IRS Service Center will notifyCare exercised to “make certain 8832 received by IRS
Certified mail receipt8832 with accepted stamp8832 with stamped IRS received date orIRS 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 - NEWRev. Proc. 2009-41, 2009-39 IRBProvides 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” regulationsForm 8832Effective 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
QualifyingRev. 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 CenterAt top “Filed Pursuant to Rev Proc 2009-41, 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
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SS-4
Application for Employer Identification Number
Electronic version
www.irs.gov
Pages 30 - 31Pages 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 1120SOther – 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 self-employment 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 non-
earnings 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 servicesPage 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 self-employment 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
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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 RicoPage 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
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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
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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)
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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
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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
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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
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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
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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 bePublically 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-the-box
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 CPage 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 CompanyUnderstanding Liquidation
Sole ProprietorshipForm 1040Schedules C, E or F
C CorporationForm 1120
PartnershipForm 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 equivalentsClass II - CDs, Gov’t Sec., stock, etc.Class III – Mark-to-market assets certain debt instrumentsClass IV – Stock in trade; inventoryClass V - All other assetsClass VI - Section 197 intangiblesClass 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
IncomeRecognition 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 non-liquidating 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.
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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
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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.
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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)
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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
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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
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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)
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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
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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
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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)
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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.
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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?
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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-1Jean has $41,000 of ordinary income from S corporation operations for the yearJean’s basis before considering distributions is $123,000 ($72,000 + $41,000 + $10,000)
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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).
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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.
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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.
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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…..
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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
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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.
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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
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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
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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.
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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
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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
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Example
Series LLC holds multiple parcels of real estate
Each is a separate series
All in one LLC
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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
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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
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Each Series May…
Sue
Be sued
Contract
Hold title to real estate and personal property
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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
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Bankruptcy
Unclear in federal bankruptcy court
Could ignore the series and consider entire LLC
Result may depend on relevant state law
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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?
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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
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History
Predicts series LLCs will be come routinely used
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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)
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#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
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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?
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Joe the Plumber
Formed an LLC, on line
Has W-2
Knows you are sooooooo
Proud
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No Form 8832 Filed
What can you do?
What should you do?
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Joe Wants to Add Partner
Wants to keep LLC
What does LLC need to do?
What are options of the LLC?
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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?
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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?
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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?
Paage
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LLC is Formed as Partnership
Two members
One withdraws – what happens?
What elections can remaining member have?
Will LLC have to get new EIN?
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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?
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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?
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New Client
Wants to go into business
Recommend how to form the business
Wants to protect his personal assets
What form do you recommend?
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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 __________.
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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?
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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?
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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?
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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?
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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?
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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?
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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?
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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
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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
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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
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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.
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LLCs
Limited Liability Companies (LLCs) have provided the tool that business owners have long desired:
Business simplicity with limited liability.
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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.
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