The article under the link below is about whether a single-member LLC’s federal tax classification as a disregarded entity should be a factor in veil-piercing. The author of the article, Tom Rutledge, is a top LLC practitioner and scholar.
The best federal income tax regimen for many LLCs whose members want to avoid Social Security Taxes is Subchapter S. In these LLCs, the members are, for federal income tax purposes, both shareholders and employees. The LLC can deduct their compensation as employees as a business expense only to the extent that this compensation is reasonable. Below is a link to a recent and useful blog post about what constitutes reasonable—and thus deductible—compensation to an employee of a business corporation who was also its sole shareholder under a recent Tax Court case. The principles underlying the post and the case it discusses apply also to members who are employees of LLCs taxable as S corporations.
Here is the link:
Believe it or not, some thousands of LLCs are publicly traded partnerships (“PTPs”). On March 9, 2015, the IRS issued a statement about the status of its work on regulations affecting certain types of PTPs. The statement is quoted below. Very few LLC accountants will ever form or work for PTPs, but all of us should at least know that they exist. Indeed, PTPs even have their own trade association. You can visit their website at http://www.naptp.org/.
Here is the recent IRS statement:
“IRS Statement on PLRs and Guidance Under 7704
We have made significant progress on our 7704 guidance project and we expect to publish proposed regulations in the near future. These proposed regulations will provide guidance on section 7704(d)(1)(E) concerning qualifying income from the exploration, development, mining and production, processing, refining, transportation, and marketing of minerals and natural resources. As has been mentioned previously by IRS and Treasury representatives, the proposed regulations will also address services provided by contractors to others in the oil and gas industry. The proposed regulations will not address other forms of qualifying income. Interested stakeholders will have an opportunity to provide comments on the proposed regulations before they are finalized and become effective. We look forward to those comments and to working with stakeholders to develop appropriate and administrable rules in this area of the law.
In the meantime, we know taxpayers have been patiently waiting for private letter rulings before proceeding with their transactions. We are pleased to report today that we are now comfortable lifting the pause in the private letter ruling process that began in 2014. During the pause, we have spent significant time studying the issues and have worked extensively with engineers in LB&I to develop workable standards to guide our ruling practice. These standards will be incorporated into the proposed regulations. P&SI is resuming the ruling process as of today, and is beginning to review the pending ruling requests, notwithstanding that we have a guidance project ongoing and that the proposed regulations, which are intended to provide greater transparency, are still being developed. We are doing so now because we recognize the importance of private letter rulings to industry participants, and we do not want to delay the availability of private letter rulings any longer where we are comfortable giving them. It may take some time to process the ruling requests as we reach out to the relevant taxpayers where additional information is needed, but we expect to work diligently to process these as promptly as we can.”
Under the Check-the-Box Regulations, both single-member and multi-member LLCs may elect to be taxable as S corporations if they meet applicable eligibility requirements, and taxation under Subchapter S can be better for these LLCs and their members than sole proprietorship taxation or taxation under Subchapter K to reduce members’ Social Security Taxes and Medicare Taxes and for other important federal tax purposes. The latest issue of The Tax Lawyer, published by the Tax Section of the American Bar Association, contains an excellent article on Subchapter S by David R. Sicular entitled “Subchapter S at 55—Has Time Passed this Passthrough By? Maybe Not.” The cite is 68 Tax Lawyer 185 (Fall 2014).
The attached recent New Hampshire Business Review article by Beth Fowler, a tax attorney with the McLane firm, provides an excellent overview of two recent rulings by the New Hampshire Department of Revenue Administration concerning the New Hampshire state tax treatment of statutory conversions of non-LLC entities to LLCs.
When you help your clients form LLCs to purchase and sell real estate, you should advise them about how to maximize the likelihood that they’ll receive capital gains treatment rather than ordinary income treat on their income from these sales. The following brief summary of a recent Tax Court case in the CCH Intelliconnect Tracker will provide your clients with solid guidelines:
LLCs’ Real Property Sales Resulted in Ordinary Income; Subject to Self Employment Tax
Sales of real property by three related LLCs produced ordinary income rather than capital gain, could not be reported on the installment method, and were subject to self-employment tax. Two of the three LLCs participated as bidders in tax lien auctions throughout Illinois, obtaining certificates of purchase of tax lien after paying taxes and other costs on tax-delinquent properties. Some certificates were assigned to the non-bidding LLC. If the lien was not redeemed by the property owner, the certificate owner would obtain a tax deed and try to sell the property as quickly as possible. Some properties were sold within one year of acquisition, some within two years, and a few after that. The LLCs reported the sales proceeds under the installment method as capital gain, either long- or short term. The IRS determined that the LLCs held the properties primarily for sale to customers in the ordinary course of a trade or business, so the proceeds were ordinary income.
The Tax Court considered various factors and determined that (1) the sales were made frequently and regularly; (2) the sales were substantial; (3) most of the properties were held for a short time; and (4) numerous people were employed to operate the LLCs’ business, all of which weighed against a finding of the properties being capital assets. The nature of the LLCs’ businesses, the relationship of the real property to those businesses, and the sales of the properties being in furtherance of those businesses also weighed against a finding of capital gain. The court concluded that the properties were not capital assets under Code Sec. 1221(a)(1) and the sales proceeds were ordinary income.
Sales of real property held in the ordinary course of a trade or business are considered “dealer dispositions” under Code Sec. 453(l) and, as such, were not reportable using the installment method. Because the sales proceeds were not capital gains, they were not excluded from the computation of net earnings and were subject to self-employment tax under Code Sec. 1402(a).
SI Boo, LLC, Dec. 60,224(M), TC Memo. 2015-19
The blog post under the link below deals with the tax consequences of sales of closely held corporate stock, but many of the general points in the post also apply to sales of LLC interests, and all of the points about sales of Subchapter S stock apply to LLCs taxable as S corporations.
Here is the link: http://www.taxlawforchb.com/2015/02/shareholder-buy-outs-in-a-closely-held-corp-part-ii/?utm_source=Tax+Law+for+the+Closely-Held+Business&utm_campaign=9400ed56fe-RSS_EMAIL_CAMPAIGN&utm_medium=email&utm_term=0_4d5d267118-9400ed56fe-73367009
If you have a reasonably active practice in forming LLCs, sooner or later you’ll be advising your LLC clients about issues, including tax issues, in selling interests in their LLCs. For a good discussion of the relevant tax issues, click on the link below. The blog post under the link deals with the tax issues of state-law business corporations, but much of its content applies equally to LLCs.
Peter Mahler, the author of a superb “business divorce” blog (whose posts I often forward to this blog), has kindly told me about another excellent blog, this one on tax, published by members of his law firm. The title of the blog is “Tax Law for the Closely Held Business.” If you want to subscribe, the link is http://www.taxlawforchb.com/. I’m certain I’ll be advising this list from time to time about new posts in the “Tax Law” blog.
New York members of this list may be interested to know that although the principal focus of the above blog is federal tax law, the blog also provides useful guidance on New York state law relevant to closely held businesses and their owners.