DEMYSTIFYING GIFTS INVOLVING LLCS MPGC 39 TH ANNUAL CONFERENCE. Selected Forms of Business Organization By U.S. Tax Return Filed

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1 DEMYSTIFYING GIFTS INVOLVING LLCS MPGC 39 TH ANNUAL CONFERENCE Mark Ladendorf Senior Relationship Manager Bill Knox Director, Planned Gift Technical Consulting Selected Forms of Business Organization By U.S. Tax Return Filed Limited Liability Companies (LLCs) 0.6 million 1.0 million 1.8 million 2.1 million S Corporations 2.7 million 3.2 million 4.0 million 4.2 million C and Other Corporations 2.1 million 2.3 million 1.9 million 1.6 million Logo on left. Page number on right: regular 12pt Source: Tax Statistics of the Internal Revenue Services ( 1

2 Number of Partnership Returns by Entity Type By U.S. Tax Return Filed for Tax Years Millions Domestic general partnership Domestic limited liability companies Foreign partnerships + Other Domestic limited partnership Domestic limited liability partnerships Source: Tax Statistics of the Internal Revenue Services ( 2 Why So Many LLCs? Avoid the double taxation of corporations Limit the liability of all members Offer more flexibility than S corps 3

3 Investment Portfolios Real Estate Variety of Assets Held in LLCs Businesses 4 Challenges Associated with Gifts Involving LLCs 5

4 Complexity Tax pitfalls Transferability 6 7

5 LLC Flow Chart Diagram 100% LLCs Disregarded Entities Disregarded Entities Outright Creates Partnership (default) Partnerships Shares/ Units Business Activities Assets Corporations Partnerships Deduction Flows through, reduces outside basis Depreciation capture Inventory/ordinary income gifts are deductible tax basis Corporations Minority interest discount Lack of marketability Other Owners Restrictions on Transfer Active or Passive Business Activities < > >or < 50% of Profits and Capital Transferred in last 12 months CGA No Technical Termination Tax free New tax election New accounting method Yes S C Corp. Corp. CRT Outright May Not or CGA Own Publicly Traded Closely Held UBTI Restrictions on Transfer Self Dealing Concerns Qualified Appraisal Unit holder Is this permissible distribution rules of LLC? Split Interest Gifts for LLC Employee Income flow Compensation through Possible to unit holders withholding according to 100% ordinary distribution rules income economic effect Outright Passive Active UBTI Substantially all? Outright or CGA S Corp. C Corp. Deduction limited to 10% of taxable income Split Interest Gifts for Assets Hot Assets Debt Installment Notes Tax Basis Yes Tax as if sold Deduction Flows through unit holders No Deduction Flows through unit holders Split Interest Gifts for Shareholder C Corp. Employee Taxes Release of Debt Acceleration of Installments Disallowances of tax losses Reduced deduction on Hot Assets Compensation Possible withholding 100% ordinary income Outright or CGA UBTI Shareholder S Corp. Employee Cash Appreciated Property CRT Self- Dealing Is this permissible under bylaws? Income flow through to all shareholders Compensation Possible withholding 100% ordinary income Taxable Dividend Reduces basis, excess taxable Capital Gain Taxable Dividend 8 Key Questions to Ask Tell me more about your business What does the company do? How long have you owned it? Has it been appraised recently? Is there debt on the business or any of its assets? Are there other owners besides you (and your spouse)? What are your plans for the future of the business? Plans to sell? Plan to transfer to other partners? Leave it your children? 9

6 Example #1: A Gift Full of Surprises Former dean owns apartment building She no longer wants to manage the property She relies on the rental income Her attorney suggests a life income gift 10 LLCs Units Business Activities Assets 11

7 Does the Donor Own 100% of Units? Yes No Disregarded Entity Partnership 12 13

8 14 Example #2: Gift of a Business Interest Couple controls business structured as an LLC Have given 35% of the company to children Want to participate in the capital campaign 15

9 The Players Houses, LLC 65% ownership 35% ownership 16 LLC Units Business Activities Assets 17

10 Does the Donor Own 100% of Units? Yes No Disregarded Entity Partnership 18 Gift Strategy LLC Units LLC Units Buyer Recognition and Deduction Payment 19

11 Sources of Liquidity Buy-Sell Agreements Valuation Issues Deduction Issues UBTI 20 Sources of Liquidity LLC unit redemption Third party buyers Other individual unit holders 21

12 Buy-Sell Agreements Allowable shareholders Terms of Sale ROADMAP BUY-SELL AGREEMENTS Sale Price Caution Issues Ahead 22 Valuation Issues Qualified appraisal Discounted for minority interest and lack of marketability Donors can have conflicting interests High value for tax deduction Low value for gift/estate tax purposes 23

13 Deduction Issues Prearranged Sale Has the gain already been earned? Revenue Ruling Facts and circumstances matter Ferguson v. Commissioner IRS bound by revenue rulings Rauenhorst v. Commissioner 24 Deduction Issues Hot Assets Unrealized receivables Highly appreciated inventory Deduction is reduced by ordinary income under Sec. 751(a) 25

14 Unrelated Business Taxable Income On active trades or businesses Debt gives rise to UBTI Top corporate tax rate: 35% Charitable trust tax rate: 100% 26 Outcome LLC Units LLC Units Buyer Recognition and Deduction Payment 27

15 Example #3: A Half-Baked Gift Former trustee owned a commercial bakery organized as an LLC He sold the business but retained the real estate He would like to supplement his retirement income 28 LLCs Units Business Activities Assets 29

16 How Is the LLC Taxed? Partnership Corporation Non-Taxable Distribution Taxable Distribution 30 31

17 Critical Questions Will the donor give units or will the LLC give assets? Ignoring the LLC, will the assets make a good gift? Is the LLC taxed as a corporation or a partnership? How many owners are there? Is ownership restricted to certain persons? Is there a buy-sell agreement in place? Is there debt in the LLC? 32 33

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