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.
Note: This was originally posted 11/18/14 but was accidentally deleted.
When you’re forming an LLC for you clients, whether it’s a single-member or a multi-member LLC, you have to teach them about veil-piercing and how to avoid it. A very recent and badly reasoned Wyoming Supreme Court decision pierced the veil of a single-member LLC . Among other things, the court reasoned that the fact that the single-member LLC is a disregarded entity for federal tax purposes is a ground for piercing. This reasoning is insane. The decision also contains dubious reasoning about undercapitalization as a grounds for veil-piercing. But you have to warn your clients about the risks posed by the case and its reasoning.
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.
John Cunningham’s free, three-CPE-credit seminar for New Hampshire accountants on the significance for LLCs of the U.S. Treasury Check-the-Box Regulations is presently scheduled for January 19, 2015 in the Chamber’s main conference room from 9 AM to 11 AM. Because of professional commitments, John has rescheduled the seminar for the same place and time on Thursday, May 21, 2015. Seating is limited. For more information and to enroll in the seminar, please call John at (603) 856-7172 or e-mail him at firstname.lastname@example.org.
Whenever you help a client form an LLC, you have to discuss with the client the Social Security Tax implications of the formation. Hence the importance of the note below from yesterday’s CCH Intelliconnect Tracker News:
The Social Security Administration (SSA) has announced that the maximum amount of earnings subject to OASDI Social Security tax will be $118,500 for 2015, up from $117,000 for 2014. The $1,500 increase reflects an overall rise in average total wages. Of the estimated 168 million workers who will pay Social Security taxes in 2015, about 10 million will pay higher taxes because of the increase in the taxable maximum, SSA reported.
For those of you who form LLCs taxable as partnerships or have clients that are members of LLCs taxable as partnerships, here is a significant news item from the latest Tax Notes:
IRS Proposed Regs Address Distributions Treated as Sales or Exchanges
The IRS has issued proposed regulations on how a partner should measure its interest in a partnership’s unrealized receivables and inventory items and on the tax consequences of a distribution that causes a reduction in that interest. (REG-151416-06)