Introduction
Themes
· Aggregate v. Entity Approach
· State Law Not Always Controlling
o Classification imposed under state law doesn’t always control for tax purposes
· Shifts in Responsibility for Liabilities Treated as Transfers of “Money”
o Section 752 Impacts
o Inside Basis: basis of the entity
o Outside Basis: basis of the partners
· Abuses of Flexibility
· Opportunities have led to several anti-abuse rules
o More flexibility of transferring assets out of the partnership into the partner
o Substance over form – Treasury Reg 1.701-2
Three Step Approach
1. Determine key business points that clients want
2. Determine what legal structures are available to carry out the intended business deal
3. Analyze the potential tax consequences and determine which entity is more beneficial
Pieces of the Puzzle
· In’s into the Deal
· Outs
· Management Decision Making
· Transfer of Ownership in the Entity
· Buy/Sell Issues
· Dissolution
Management Decision-Making
Just because somebody owns more than 50% of the economic interest of a partnership, it doesn’t mean he controls the partnership. That gets set up separately
Book Capital Accounts
Economic Scorecard – Keep track of what you put in to the partnership
· Adjusted for any shares of income allocated to you but not yet received
· FMV of contributed/distributed property
· If you make the partnership assume a liability, it’s a deduction
From a Tax Standpoint…
Tax consequences upon the formation of an entity
· Recognition of gain/loss upon formation
· Basis implication at the entity level and owner level
Tax consequences of the operation: Flow Through; Double Tax
Tax consequences upon dissolution/termination
· Distribution of money and property
Check-the-Box Classifications
Check the Box Regs – 301.7701-1 through 301.7701-5
· Is the arrangement an entity?
Remember: Federal tax entity isn’t the same as entity under local law
· Is the entity a trust or business entity?
· If business entity, is it
o Treated as Corporation per se (i.e. state law corporation)
o Eligible Entity
· If eligible entity, may choose classification
o Corporation
o Partnership – default classification if more than one member (disregarded if only one member)
Per Se Domestic Corporation
Certain business entities are automatically classified as corporations
· Organized under a Federal or State statute, if the statute describes or refers to the entity as incorporated or as a corporation
· Organized under a State statute, if the statute describes or refers to the entity as a joint-stock company or joint-stock association
· Taxable as an insurance company
· State-chartered and conducts banking activities, if insured by FDIC
· Wholly owned by the state
· Taxable as a corporation under a provision other than §7701(a)(3)
Classification
Check the Box Regs apply to business entities regardless of the number of owners
· 2+ Members
o Business entity not a per se corporation is a partnership, unless an election is made to treat it as a corporation
o Thus, unincorporated entity (LLC, LP) is automatically classified as partnership unless an
, clothing store)
Capital Interest in a Partnership
· An interest in the assets of the partnership, which is distributable to the owner of the capital interest upon his withdrawal from the partnership or upon liquidation of the partnership
· Note: You may transfer part of your interest to a child and have him treated as partner in a situation where capital is the material income-producing factor. But, this isn’t the case if it’s a service-based business (i.e. consulting)
Dividing Profits
In defining a member who can be a partner, an important question is what does it mean to ‘divide’ profits?
· Partnership is created for federal tax purposes if the participants carry on a trade, business, financial operation or venture and divide the profits therefrom
· Is Not sharing of the contingent risks and rewards of participation
· Is profits derived from the same business or asset pool, and not some 3rd-party capacity, such as employee or lender
· Is multiple classes of interest sharing profits from the same asset pool
o Even if 1st preferred class doesn’t have the same risk as underlying profit sharers
· Is division of cash profits and in-kind contribution (Madison Gas)
As a result of Madison Gas, to not be subject to Sub K, must elect out under 761(a)(2)
