PORTFOLIO

Limited Liability Companies (Portfolio 725)

Tax Management Portfolio, Limited Liability Companies, No. 725-3rd, focuses on the federal tax consequences of using a limited liability company (LLC) for conducting business operations. It is not a primer on the fundamentals of partnership taxation.

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DESCRIPTION

Tax Management Portfolio, Limited Liability Companies, No. 725-3rd, focuses on the federal tax consequences of using a limited liability company (LLC) for conducting business operations. It is not a primer on the fundamentals of partnership taxation.


The tax factors in choosing an LLC are compared to regular corporations, S corporations, and partnerships as alternative business forms for tax purposes; and various uses of the LLC are summarized.


The tax consequences of converting partnerships and corporations to LLC status are discussed. Classification of the LLC is examined in detail and the unique federal tax consequences of using the LLC are discussed. Analysis and commentary are provided to the tax practitioner to assist in resolving the tax issues encountered when using an LLC.
Compensation issues are analyzed for the potential impact on LLC members. International use of the LLC is explored in detail and the state tax consequences are summarized to assist the tax practitioner in generalizing these consequences when using the LLC interstate.


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AUTHORS

KAREN LOHNES
Karen Lohnes, B.S., Accounting, Louisiana State University; J.D., summa cum laude, Boston University School of Law; Editor, Boston University Law Review; member, ABA Partnership Tax Committee; author, articles published in International Tax Journal, University of Southern California Tax Institute's Major Tax Planning, The Tax Advisor.

JEFFREY I. ROSENBERG
Jeffrey I. Rosenberg, undergraduate degree, University of Rhode Island; J.D., Western New England College School of Law; LL.M. in Taxation, Georgetown University Law Center; formerly Attorney-Advisor, Passthroughs and Special Industries Division of the Office of Chief Counsel, Internal Revenue Service; speaker and lecturer, various tax institutes; author, various articles on tax issues in partnership area.

JOHN G. SCHMALZ
John G. Schmalz, B.A., University of Wisconsin, Milwaukee; J.D., Marquette University; formerly Attorney-Advisor, Legislation and Regulations Division, Office of the Chief Counsel, Internal Revenue Service; member, American Bar Association, Tax Section (Partnership Committee), State Bar of Wisconsin; Vice Chairman, ABA Partnership Tax Committee's Subcommittee on like-kind exchanges; author, articles published in Journal of Partnership Taxation, Journal of Taxation, Journal of Real Estate Taxation, and Journal of S Corporation Taxation.

SAMUEL P. STARR
Samuel P. Starr, B.S., Pennsylvania State University; J.D., University of Virginia; LL.M. in Taxation, Georgetown University Law Center; former member, AICPA, Partnership Tax Committee; former Chair, AICPA S Corporation Committee; former Co-Chair, ABA Tax Section Task Force on Taxable and Tax-Free Acquisitions Involving S Corporations; Adjunct Professor, Georgetown University Law Center; member, Board of Advisors, Journal of Business Entities; Department Editor, Journal of Taxation; speaker and lecturer, various tax institutes; author, Tax Management Portfolios 730-2nd and 731; member, State Bars of Pennsylvania and District of Columbia.

ROBERT J. CRNKOVICH
Robert J. Crnkovich, B.S., J.D., Marquette University; LL.M. in Taxation, Georgetown University Law Center; Adjunct Professor, Georgetown University Law Center; formerly Senior Counsel, Office of Tax Policy, US Department of Treasury; member, State Bars of Wisconsin, California, and District of Columbia.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction: Choice of Entity Considerations

Introductory Material

A. LLCs Compared to Corporations

1. Limited Liability

2. Presence of Governing Board

3. Perpetual Life

4. Restrictions on Transferability

5. Familiarity

B. Tax Factors to Consider in Choosing the LLC

1. Tax Rate Differentials

2. Single-Tier Tax

3. Transfers of Appreciated Property

a. Transfers to Entity

b. Transfers from Entity

4. Corporate Alternative Minimum Tax

5. Entity Level Debt

6. Passive Activity Loss Rules

7. Special Allocations

8. Eligibility Requirements

9. Cash Method of Accounting

10. Taxable Year

11. Fringe Benefits

12. Accumulated Earnings and Personal Holding Company Taxes

II. Converting to LLC Status

Introductory Material

A. Existing Corporations

1. Existing C Corporations

a. Double Taxation

b. Form of Conversion

2. Existing S Corporations

3. Liquidation-Reformation as LLC

B. New Operations

C. Converting Personal Service Corporations to LLCs

D. Converting Partnerships to LLCs

1. Termination of Existing Partnership

2. Cash Method of Accounting

3. Unrealized Receivables and Inventory

4. Disguised Sales

E. Conversions under the Check-the-Box Rules

F. Conversions Involving Mergers and Divisions of Partnerships

G. Mergers of Corporate Entities and Disregarded Entities

III. Partnership Classification

A. Entity Classification after December 31, 1996: The “Check-the-Box” Regulations - General Approach

B. Business Entities

1. General Approach

2. Foreign vs. Domestic Entities

3. Distinguishing Trusts from Business Entities

4. Classifying a Post-1996 Business Entity

5. Entities with More than One Member

6. Clarifications Regarding Listed Foreign Per Se Corporations

7. Special Grandfather Rule for Pre-existing Foreign Business Entities

8. Redetermined Trusts

C. Classification of Eligible Entities

1. Ability to Elect Classification

2. Disregarded Entities

3. Election vs. Default

4. Default Rules for Domestic Entities

5. Default Rules for Foreign Entities

6. Limited Liability

7. Existing Eligible Entities

8. Making an Election

9. Limitation on Ability to Change Election

10. Deemed Election Rules

11. Manner of Signing and Authorizing an Election

12. Relevance of a Foreign Entity's Classification

13. Section 708(b)(1)(B) Termination

14. Change in Number of Owners

15. Revenue Ruling 99-5

16. Revenue Ruling 99-6

17. Elective Changes in Classification

18. Special Rules for Qualified Stock Purchase

19. Special Rules for Tiered Structures

20. Effective Date and Transition Rules

D. Prior Law - Partnership Classification Regulations

IV. Application of Partnership Rules to LLCs

A. Overview of Subchapter K

1. General Rules

a. Entity versus Aggregate Theories of Partnership Taxation

b. Partnership as “Taxpayer”

c. Formation of Partnership

d. Partnership Liabilities

e. Partnership Allocations

f. Partnership Distributions

g. Sales of Partnership Interests

2. Application of Partnership Rules to LLCs

B. Characterization of LLC Debt as Recourse or Nonrecourse

1. Character of Debt for Purposes of Subchapter K Rules

2. Impact of Deficit Restoration Obligation on Character of Debt

a. Introduction

b. Impact of DRO on Equity Allocations

c. Impact of DRO on Recourse Debt and Loss Allocations

(1) Absence of a DRO

(2) Guarantee; No DRO

(3) Presence of a DRO

C. Allocations of Debt, Income, Gain, Loss, Deduction, and Credit

1. Overview

a. Section 752: Debt Allocations

b. Section 704(b): Income and Loss Allocations

2. Allocations of Recourse Liabilities Under § 752

3. Allocations of Nonrecourse Liabilities Under § 752

a. Partnership Minimum Gain

(1) In General

(2) Application of Regulations to LLCs

b. Section 704(c) Minimum Gain

(1) Section 704(c) Overview

(2) Section 704(c) Minimum Gain Computation

(a) Multiple Properties Subject to Debt; State Law Recourse LLC Debt

(b) Use of § 704(c) Remedial Allocation Method

c. Excess Nonrecourse Liabilities

4. Allocations of Income, Gain, Loss, Deduction, and Credit Under § 704(b)

D. Death or Retirement from Service LLCs

1. Background

2. Impact of 1993 Changes to Service LLC Members

E. Administrative Partnership Provisions - Partnership Level Audits

F. Election Out of Subchapter K

V. Application of Other Technical Rules to LLCs

A. Cancellation of Debt Provisions

1. Overview

2. Character of Debt for Purposes of COD Income Rules

a. Non-Guaranteed “Recourse Debt”

b. Guaranteed “Nonrecourse” Debt

c. Summary

B. Passive Activity Rules

1. Treatment of Members as Limited or General Partners

2. $25,000 Active Participation Exception

3. Application of § 469(c)(7) Real Estate Rule

4. Grouping Activities

C. Use of Cash Method of Accounting

D. At Risk Rules

E. Like-Kind Exchanges

1. Overview

2. Application to LLCs

F. Capitalization of Transaction Costs

VI. Tax Treatment of Self-Employment Earnings, Fringe Benefits and Other LLC Compensation Issues

Introductory Material

A. Summary of the Self-Employment Rules

1. Limited Partners Not Subject to Self-Employment Tax

2. Is the LLC Member a General or Limited Partner?

B. Taxation of Fringe Benefits

1. Fringe Benefits Defined

2. Rev. Rul. 91-26

3. Other Fringe Benefits

4. Alternative Treatment

5. Self-Insurance

6. Summary

C. Other LLC Compensation Issues

1. Employee or Member?

2. Use of Deferred Compensation Arrangements

3. Equity-Based Compensation for Members

a. Capital Interests

b. Profits Interests

c. Forfeitures of Restricted Interests Under § 83

4. Options to Acquire LLC Interests

5. Use of Incentive Stock Options

6. Compensating Members with Corporate Member Stock

a. TAM 9822002 and PLR 9853038

b. Revenue Ruling 99-57

c. Section 1032 Regulations

VII. Foreign LLCs

Introductory Material

A. Classification of Foreign LLCs

B. Other Classification Issues for Foreign LLCs

1. Limitation on Foreign Entity Classification

2. Expansion of Per Se List to Include Foreign LLCs

C. Factors to Consider in “Choosing” U.S. Classification Status of Foreign LLCs

1. Transfers to LLCs

a. In General

b. Outbound Transfers to Corporations

c. Outbound Transfers to Partnerships

2. Deferral

a. In General

b. U.S. Corporate Status

(1) In General

(2) Subpart F

(3) Passive Foreign Investment Company

c. U.S. Partnership Status

(1) In General

(2) Income

(3) Expenses and Losses

(4) Passive Foreign Investment Company

(5) Partnership Tax Year

3. Foreign Tax Credit Implications

a. In General

b. U.S. Corporate Status

(1) Separate Foreign Tax Credit Limitations

(2) Deemed Paid Foreign Tax Credits and Third-Tier Rule

(3) Expense Allocation Rules

c. U.S. Partnership Status

(1) Separate Foreign Tax Credit Limitations

(2) Deemed Paid Foreign Tax Credits and Third-Tier Rule

(3) Expense Allocation Rules

D. Hybrid LLCs

E. Inbound Issues

1. Use of LLC Hybrids

2. Effectively Connected Income of § 884

3. Branch Profits Tax

F. Treaty Issues

1. Outbound Issues

2. Inbound Issues

VIII. State Tax Issues

A. In General

1. Corporate Taxes

a. Nexus

b. Structure

2. Individual Taxes

a. Residency

b. Structure

B. State Taxation of Pass-Through Entities

1. Recognition of Pass-Through Status

2. Non-Recognition of Pass-Through Status

3. State Taxation of Owners

a. Withholding for Nonresident Owners

b. Credits for Taxes Paid to Other States

c. Apportionment for Non-Individual Members

4. Other Business Taxes Affecting Pass-Through Entities

C. State Taxation of LLCs

1. In General

2. Characterizing LLCs as Corporations or Partnerships

3. States That Do Not Impose Corporate Income Taxes

4. Entity-Level Taxes on LLCs Classified for Federal Purposes as Partnerships

5. LLCs Taxable as Corporations

6. LLCs Taxable as Partnerships

a. Withholding for Nonresident Members

b. Composite or Consolidated Returns

c. Credits for Taxes Paid to Other States

7. Apportionment for Non-Individual Members

8. Other State Taxes

9. Real Estate Transfer Taxes

10. Franchise Taxes on Capital Values


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Delaware LLC Act

Worksheet 2 Sample LLC Operating Agreement [Maryland law]

Worksheet 3 Limited Liability Companies State-by-State Summary

Worksheet 4 REG-209824-96, 62 Fed. Reg. 1702 (1/13/97), Proposed Regulations on the Definition of Limited Partner for Self-Employment Tax Purposes

Worksheet 5 Rev. Rul. 99-5, 1999-1 C.B. 434

Worksheet 6 Rev. Rul. 99-6, 1999-1 C.B. 432

Bibliography

OFFICIAL

Statutes:

Treasury Rulings:

Cases:

UNOFFICIAL

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Periodicals:

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