Taxation of LLCs – an Overview

1. Taxation of LLCs – an Overview

2. A Brief History of the LLC • Before 1960 (limited liability meant corporate tax treatment) • Kinter regulations (2 of 4) • 1) Limited Liability • 2) Centralized Management • 3) Freely transferable ownership interests • 4) Continuity of life

3. A Brief History of the LLC • 1977 Wyoming LLC Version 1.0 • Master Limited Partnerships Problem • 1997 IRS changes course – who says there is no such thing as a free lunch? • Check the Box

4. Check the Box • Single Member LLCs • Partnership • Corporation

5. Self Employment Issues • Self-employment tax 12.4% up to SS base ($113,700) plus 2.9% uncapped (with increase marginal rate to 3.8% in 2013) • 1997 Proposed Regs for limited partners (500 hour test) • New Obamacare passive activity income 3.8% marginal rate over income thresholds • Increased incentive for active businesses to be S corps rather than LLCs

6. Section 721 Transactions • No gain or loss • No 80% rule (unlike 351) • Disguised Sale exceptions (i.e. watch out for distributions following contributions within 2 years)

7. Partnership Allocations

8. Capital Accounts • Required maintaince • Book Capital accounts • Tax capital accounts (i.e. outside basis) • Importance of examples

9. Drafting Tax Allocation Provisions • Pro rata generally not problematic. • Substantial Economic Effect and other tax provisions: • Qualified Income Offset • Capital Accounts • Deficit Reduction Obligation • Minimum Gain (nonrecourse debt) • Contributed property & Bookups • 754 adjustments • Important not only to include “boilerplate” tax language but also to understand effects • Safe Harbor vs. Targeted Allocation Drafting • A trap for the unwary

10. Dealing with Preferred Returns • Profits are easy, losses are hard • The basic test for substantial economic effect

11. Substantial Economic Effect • Capital Accounts • Liquidating distributions in accordance with capital accounts • Either a DRO, or • Qualified Income Offset & Minimum Gain Chargeback • Economic Equivalence Test (Dumb but Lucky)

12. Qualified Income Offset • Any Holder with a deficit in his/her capital account, as the result of unexpectedly receiving a distribution, must be allocated items of future income or gain in an amount sufficient to eliminate the deficit balance as quickly as possible. • Shift Income/Gain to members with a deficit

13. Minimum Gain Chargeback • Requires that Holders who are allocated loss or depreciation deductions (i.e. nonrecourse deductions) with respect to an asset secured by nonrecourse financing must also be allocated the first gain from the sale of such asset, up to the amount of the prior deductions.

14. Targeted Allocation Provisions • First the economics • Then allocation in manner to cause ending capital accounts to equal result in liquidation. • Burden is transferred from drafter to tax return preparer • Does not comply with safe b • No certainty yet, but moving that way

15. Profits Interest • Tax consequences to recipient • Tax consequences to company • 409A issues

16. Conclusion • Good luck out there!