Advanced Tax Strategies for LLC and Partnership Transactions

• Chapter 1 - Partnership Tax Update
  • Learning Objectives
  • Additional 3-, 4-, and 5-Year Carryback of Net Operating Losses Allowed for Eligible Small Businesses
    • American Recovery and Reinvestment Act of 2009, PL 111-5, February 17, 2009
    • Making the Election
  • Valuation of a Partnership Interest Under Section 108(e)(8) When Used to Satisfy Partnership Obligations
    • Preamble to Prop. Reg. October 30, 2008, Prop. Reg. §1.108-8, Prop. Reg. §1.721-1.
  • The Effect of Issuance of New Regulations on the Authority of Older Regulations
    • Kandi v. U.S., (CA 9 September 25, 2008), 102 AFTR 2d ¶2008-5342
  • Deficit Restoration Obligation Does Not Increase Owner’s At-Risk Amount with Respect to the Entity’s Recourse Liabilities
    • Hubert Enterprises, TC Memo. 2008-46, February 28, 2008
  • Interest Expense Allocated to Limited Partner in Trading Partnership is Subject to Investment Interest Expense Limitation
    • Rev. Rul. 2008-12
  • Regulations §1.752-6 Can Be Applied Retroactively
    • Cemco Investors, 2008-1 USTC ¶50,178 (CA-7, February 7, 2008)
  • Statute of Limitations – Regs. §1.752-6 and Abusive Partnership Tax Shelters
    • Brandon Ridge Partners, 2007-2 USTC ¶50,573 (July 30, 2007); Salman Ranch, Ltd., 2007-2 USTC ¶50,803 (November 9, 2007)
  • Other “Son of BOSS” Cases Decided as Well
  • Deemed Election to Deduct or Amortize Organizational Expenses and Syndication costs
    • Reg §1.709-1T (July 7, 2008)
  • Extension of Time to File a Partnership Tax Return
  • Penalty for Failure to File a Partnership Tax Return
  • Family Limited Partnership Disregarded – Again!
    • Family Limited Partnerships – in General
    • Bigelow, 2007-2 USTC ¶60,548, (CA-9, 9/14/2007)
    • Thomas H. Holman, Jr., et ux. v. Commissioner, 130 TC No. 12
    • HR 436 – Elimination of Many Valuation and Minority Discounts
  • Final Regs. Explain Partnership Allocations of Look-Through Entity Partners
    • T.D. 9398, May 16, 2008; Reg. § 1.704-1
  • Taxpayer's Rental Income Meets "Insubstantial" Passive Activity Loss Exception
    • Candelaria, 2007-2 USTC ¶50,785 (October 5, 2007)
• Chapter 2 - Disproportionate Distributions
  • Learning Objectives
  • Introduction
  • Hot Assets
    • Unrealized Receivables
    • Substantially Appreciated Inventory
  • Distributions Affected
    • In General
    • Some Flexibility Remains
    • “Exempt” Distributions
  • Determining the Consequences of a Disproportionate Distribution under Section 751(b)
    • Mechanics
    • Partnership or LLC May Also Have Gain
  • Filing Requirements
  • Questions
• Chapter 3 - Distributions of Contributed Property
  • Learning Objectives
  • Introduction
  • Section 704(c)(1)(B) – Mechanics
    • Distributions of Contributed Property within Seven Years
    • Adjustments to Basis
    • Successors in Interest
    • Interaction with Section 708
  • Exceptions
    • Complete Liquidations
    • Certain Distributions of "Like-Kind" Property
  • Sec. 737: Recognition of Built-in Gains on Partnership or LLC Distributions
    • Section 704(c)(1)(B)
    • Section 737
    • Broad Scope of 737
    • Basis Adjustments
    • Exceptions and Special Rules
  • Questions
• Chapter 4 - Section 707(a)(2): Disguised Sales between Partners or LLC Members and Partnerships/LLCs
  • Learning Objectives
  • Introduction
  • General Principles
    • Legitimate Interest in Partnership Capital
    • Partial Sales
  • Requirements for Sale Treatment
  • Presumption for Transfers within Two Years
  • Circumstances Suggesting that Transactions Not Occurring within Two Years Are Related
  • Offsetting Factors
    • Repayment Required
    • Risk Related Factors
  • Transfers Disguised as Cash Flow Distributions
  • Payments Exempted from Sale Treatment
    • Guaranteed Payments for Capital
    • Cash Flow Distributions
    • Reimbursement of Pre-Formation Expenditures
  • Treatment of Liabilities
    • Liabilities Assumed by the Partnership
    • Exception for "Qualified" Liabilities
  • Treatment of Qualified Liabilities When Transfer Is Treated as Part of a Sale
  • Debt-Financed Distributions to a Partner or LLC Member
  • Disguised Sales by a Partnership or LLC to a Partner or Member
  • Disclosure Requirements
  • Questions
• Chapter 5 - Death or Retirement of a Partner: Capital-Intensive vs. Service Partnerships
  • Learning Objectives
  • Introduction
  • Sale of an Interest in a Partnership or LLC
    • Generally
    • Effect of Liabilities
    • Hot Assets and Section 751(a)
  • Death or Retirement of a Partner from Professional Services Partnerships – Application of Section 736
    • General Application of Section 736
    • Structuring the Transaction to Avoid Section 736
    • Character of the Departing Partner’s Capital Gain
    • Amortization of Goodwill Payments by the Partnership
    • Multiple Payments
  • Partnerships in Which Capital is a “Material Income-Producing Factor” and Section 751(b)
    • Section 751(b)
    • Potential Costs of Section 751(b) to the Partnership
  • Questions
• Chapter 6 - Troubled Debt Transactions
  • Learning Objectives
  • Introduction
  • Options Available to the Lender and the Borrower
  • Foreclosure
    • Recourse Debts
    • Nonrecourse Debts
  • Changes in the Terms of a Loan
  • Partial or Total Forgiveness
    • Recourse Debts
    • The Insolvency Exception of Section 108
    • Nonrecourse Debts
    • Seller Financing
  • Section 108(c): Qualified Real Property Business Indebtedness
    • Overview
  • What Is Qualified Real Property Business Indebtedness?
  • Subsequent Disposition of Property
  • Section 108(g): Qualified Farm Indebtedness
    • Overview
    • Qualified Farm Indebtedness
  • Section 108(i) Reacquisition of Debt Instruments
    • Deferral of Business-related COD Income Realized in 2009 or 2010
    • Broad Definition of “Acquisition”
    • Election as Alternative to Deferral under Other Provisions of §108
    • Acceleration of Deferred Income
  • Special Problems for Partnership and LLC Debtors
    • Overview
    • Who Recognizes COD Income?
    • Allocation of COD Income
    • Timing of Partnership COD Income
    • Partnership or LLC Real Property Business Indebtedness
    • Exchange of Debt for a Partnership or LLC Interest
    • Election by a Partnership to Defer COD Income under Sec. 108(i)
    • Acceleration of Deferred Partnership COD Income under Sec. 108(i)
  • Summary and Concluding Remarks
  • Questions
• Chapter 7 - Advanced Capital Structure – Tiered Partnerships, Mergers, Divisions and the Use of Non-compensatory Options
  • Learning Objectives
  • Tiered Partnerships
    • Introduction – Overview of Tax Issues Arising from the use of Tiered Partnerships
    • Formation – Transfer of Property or Cash to a Lower-Tier Partnership
    • Flow-Through of Lower-Tier Partnership Items to Partners in Upper-Tier Partnerships
    • Allocation of Income, Deductions, Etc.
    • Basis Adjustments under §734(b) or §743(b)
    • Measurement of Hot Assets under §751
  • Coordination with §1032 when One of the Partners Is a Corporation
  • Partnership Mergers and Divisions
    • Overview – Merger or Consolidation of Two or More Partnerships/LLCs
    • Tax Consequences of a Partnership Merger
    • Tax Returns and Elections
    • Which Partnership Survives?
    • Partnership Divisions
  • Tax Consequences Associated with Noncompensatory Options
    • Issuance, Exercise, and Lapse of Noncompensatory Options
    • Accounting for the Exercise of Noncompensatory Options
    • Option Holder Treated as a Partner in Certain (Rare) Circumstances
  • Questions
• Chapter 8 - Latest Developments
• Appendix A - Partnership Return of Income Checklist
• Appendix B - Form 1065 and Schedule K-1

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The Effect of Issuance of New Regulations on the Authority of Older Regulations

Kandi v. U.S., (CA 9 September 25, 2008), 102 AFTR 2d ~¶~2008-5342

In Kandi,⁷ the U.S. Court of Appeals for the Ninth Circuit ruled that the sole owner of a limited liability company (LLC) was personally liable for the LLC's unpaid payroll taxes, even though the Code did not clearly address how LLCs should be taxed, and even though regulations later were issued that would not have held the taxpayer liable for the taxes.

In March 1999, Emiel Kandi and a business partner formed Lounge Lizards, LLC. Kandi and his business partner were the only members of the LLC. In January 2001, Kandi bought out his partner's interest in the LLC and became the sole member of the LLC. In September 2001, Kandi sold all of his interest in Lounge Lizards, LLC, to another individual.

During the first two quarters of 2001, Lounge Lizards, LLC incurred employment tax liabilities of $101,024.06 and $115,226.90, respectively. The parties do not dispute that these liabilities remain unpaid. The Internal Revenue Service (IRS) attempted to collect the unpaid employment taxes from Kandi personally on the theory that because Kandi had never filed an election (Form 8832) to have Lounge Lizards, LLC be taxed as a corporation during the time period at issue, Kandi, as the owner and single member of the LLC, was also the employer responsible for payment of employment taxes.

After a collection due process hearing at which Kandi was permitted to voice his opposition, the IRS determined that the collection action against Kandi (instead of the LLC) was proper. Kandi then filed an action in a District Court, seeking judicial review of the IRS's decision. During the time the parties' cross-motions were pending, the IRS issued proposed regulations squarely addressing the single issue at stake in this case, and supporting Kandi. The Court permitted additional briefing regarding the parties' positions on applicability to or other impact of the proposed regulations on the present case. The District Court held for the IRS, and Kandi appealed to the Ninth Circuit Court of Appeal.

The Ninth Circuit concluded that the IRS's interpretation of the Internal Revenue Code at the time the employment taxes were incurred was reasonable. The regulations at issue (those in effect at the time the employment taxes were incurred) were a reasonable attempt by the Treasury Department to fill in gaps left in the statute regarding the taxation of LLCs and other new forms of business entities. The later decision by the IRS to adopt new regulations regarding the taxation of sole member LLCs was held not to change the result. The Ninth Circuit held that the new regulations are applicable to taxes on wages paid after January 1, 2009, and thus did not apply to Kandi's unpaid 2001 employment taxes.

The Court also opined that the IRS’s later decision to adopt an alternative approach also does not mean that the regulations challenged were incompatible with the statute. Because the IRS’s attempt to fill in gaps in the Internal Revenue Code was reasonable, the Circuit Court affirmed the District Court's decision granting summary judgment to the IRS.

Deficit Restoration Obligation Does Not Increase Owner's At-Risk Amount with Respect to the Entity's Recourse Liabilities

Hubert Enterprises, TC Memo. 2008-46, February 28, 2008

In essence, the regulations issued in 2006 take the position that the owner of a single member LLC does not bear personal responsibility for otherwise recourse liabilities of the LLC unless the owner personally guarantees those liabilities. The owner's risk of loss is limited to the net value of assets of the LLC to which the creditors will ultimately have recourse in the event of default on the debt.

The Tax Court has extended this position in a 2007 case, Hubert Enterprises. In this case, taxpayer was one of two members of an LLC that purchased equipment and partially financed its purchases using recourse debt. The members amended the LLC's operating agreement to add deficit capital account restoration obligation (DRO). They then used this DRO to support the allocation of additional LLC recourse liabilities to taxpayer.

The Tax Court ruled that the additional recourse liabilities allocated to taxpayer in connection with the DRO did not increase taxpayer's amount at risk with respect to the LLC. The court determined that the DRO did not create an "unconditional obligation" on the part of the taxpayer to contribute additional capital to the LLC. The court's rationale was the DRO would require the taxpayer to make an additional contribution to the LLC only if the taxpayer liquidated its interest in the LLC at a time when it had a deficit balance in its capital account. Because a recourse creditor lacks the power to force the taxpayer to liquidate his interest in the LLC, the creditor could not force the taxpayer to make good on the recourse debt in the event of an LLC default. Thus, the court reasoned that the obligation caused by the DRO was contingent on the taxpayer voluntarily liquidating his interest in the LLC.

The rest of the Tax Court's opinion is somewhat more difficult to defend. It further suggested that even in the event the taxpayer did liquidate his interest in the LLC, his obligation would be limited to the deficit balance in his capital account, which may or may not equal his allocable share of the LLC's recourse liabilities. While this is true, if the allocated share of recourse liabilities exceeds the deficit balance in the taxpayer's capital account, the difference is likely due to a misapplication of the ~§~752 regulations under which recourse liabilities are allocated.

Finally, the Tax Court asserted that even if taxpayer actually makes an additional contribution to the LLC under the DRO, there is no requirement that any of the additional contribution be paid to creditors of the LLC. The DRO states specifically that the LLC may transfer the additional contribution to its members with positive capital accounts. Again, this argument appears to be inconsistent with the regulatory framework underlying the allocation of recourse debts. In the event that some partners have negative capital balances and others have positive balances at liquidation of the partnership or LLC, those with deficit balances are obligated to make additional contributions to the partnership/LLC. These contributions may be used to liquidate the positive balances in other partners' capital accounts, but only after partnership recourse liabilities have been satisfied. In such a case, the deficit balance in one or more partner/member's capital accounts would, in the aggregate, exceed the partnership/LLC's outstanding recourse liabilities. In such a case, they would also exceed the share of such recourse liabilities allocated to those partner/members obligated under the DRO.

In sum, the Tax Court, in Hubert Enterprises, appears to be inconsistent with the regulatory framework underlying the Section 752 regulations. It will be interesting to see how this argument develops in subsequent cases.

⁷ Kandi v. U.S., (CA 9 9/25/08), 102 AFTR 2d ~¶~2008-5342.

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