Structuring Tax Provisions in Partnership and LLC Operating Agreements Effective Allocations With Flow-Through Entities

Transcription

1 presents Structuring Tax Provisions in Partnership and LLC Operating Agreements Effective Allocations With Flow-Through Entities A Live 90-Minute Audio Conference with Interactive Q&A Today's panel features: Gregory V. Nelson, Partner, Baker Botts, Houston Carolyn R. Turnbull, Director of Tax, Moore Stephens Tiller, Atlanta Thursday, July 30, 2009 The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific The audio portion of this conference will be accessible by telephone only. Please refer to the dial in instructions ed to registrants to access the audio portion of the conference. CLICK ON EACH FILE IN THE LEFT HAND COLUMN TO SEE INDIVIDUAL PRESENTATIONS. If no column is present: click Bookmarks or Pages on the left side of the window. If no icons are present: Click View, select Navigational Panels, and chose either Bookmarks or Pages. If you need assistance or to register for the audio portion, please call Strafford customer service at ext. 10

2 STRUCTURING TAX PROVISIONS IN PARTNERSHIP AND LLC OPERATING AGREEMENTS July 30, 2009 TABLE OF CONTENTS I. Property Contributions... 2 II. Distributions... 6 III. Tax Distributions IV. Hurdles and Preferred Returns V. Partner-Partnership Transactions VI. Liquidation Mechanics VII. Allocations VIII. Capital Accounts IX. Regulatory Allocations X. Income Tax Allocations XI. Tax Audit Provisions HOU02:

3 I. PROPERTY CONTRIBUTIONS HOU02:

4 5.01 Initial Contributions. Example 1 All Partners Contributing Property (a) Simultaneously with the execution hereof, and pursuant to that certain Assignment, Bill of Sale and Assumption Agreement executed concurrently herewith by and between the General Partner and the Partnership (the Transfer Agreement ), the Partners have contributed to the capital of the Partnership the portions of the Operating Assets set forth opposite their respective names below under the heading Capital Contributions. The Partners capital percentages (the Capital Percentages ) shall be as set forth opposite their respective names below under the heading Capital Percentages : Capital Percentages Capital Contributions General Partner 1% 1% of the Operating Assets Capital Percentages Capital Contributions Limited Partner 99% 99% of the Operating Assets (b) Simultaneously with the execution hereof, and pursuant to the Transfer Agreement, the Partnership shall also assume the Operating Liabilities. 99% of the Operating Liabilities shall be assumed by the Partnership on behalf of the Limited Partner, and 1% of the Operating Liabilities shall be assumed by the Partnership on behalf of the General Partner. (c) For convenience, the General Partner and the Partnership agreed in the Transfer Agreement to the direct transfer of the Operating Assets from the General Partner to the Partnership and to the direct assumption of the Operating Liabilities by the Partnership on behalf of the General Partner. The Transfer Agreement further provides, and the Partners hereby agree, that (i) in accordance with Section 4.1 of the Limited Liability Company Agreement of the Limited Partner, the General Partner shall be deemed to have transferred to the Limited Partner a 99% interest in the Operating Assets, and the Limited Partner shall be deemed to have assumed on behalf of the General Partner 99% of the Operating Liabilities, and (ii) in accordance with Section 5.01(a) and 5.01(b) of this Agreement, the Limited Partner shall immediately thereafter be deemed to have transferred to the Partnership such 99% interest in the Operating Assets, and the Partnership shall be deemed to have assumed such 99% of the Operating Liabilities on behalf of the Limited Partner. HOU02:

5 Example 2 Contributions of Cash and Money Section 6.1 Initial Capital Contributions. As contemplated in the Contribution Agreement: (a) prior to the making by Partner 2 of the contribution referred to in Section 6.1(b), Partner 1 shall contribute, convey, assign, transfer and deliver all of its legal and beneficial interest in Operating Company and all other Contributed Assets, based on which, the Company shall be deemed to have an initial equity value of $150,000,000; and (b) Partner 2 shall contribute the Initial Investor Contribution Amount to the Company. HOU02:

6 Example 3 Straightforward Property Contribution Section 3.1 Initial Contributions. On the Closing Date, each Member made those contributions to the Company that are provided for in Section of the Contribution Agreement and the amounts set forth in Exhibit A (the Initial Contributions ). As a result of such Initial Contributions, each Member shall have the Member Interest set forth opposite such Member s name on Exhibit A. HOU02:

7 II. DISTRIBUTIONS HOU02:

8 Example 1 Simple Waterfall with IRR Section 5.4 Distributions. Except as otherwise provided in Section 5.5, any Available Cash or other property shall be distributed to the Members solely at such times and in such amounts as the Board of Managers shall determine. Each such Distribution shall be made in cash in the following priorities and ratios: (a) first, to Members holding Class B Units in accordance with their then existing Class B Sharing Percentages until each such Member has received distributions sufficient to cause its IRR for Class B Units to be ten percent (10%) ( Payout 1 ); (b) second, as long as Payout 1 is satisfied, to Members holding Class A Units in accordance with their then existing Class A Sharing Percentages until they have received distributions equal to their respective Capital Contributions for Class A Units ( Payout 2 ); and (c) third, as long as Payouts 1 and 2 are satisfied, to Members in accordance with their then existing Sharing Percentages. HOU02:

9 Example 2 Waterfall Distribution Without IRR 6.5 Distributions of Company Net Cash Flow. No distribution of Company Net Cash Flow shall be made prior to the Completion Date for Phase I. After the Completion Date for Phase I, Company Net Cash Flow shall be distributed no less frequently than quarterly as follows: thereof. (a) First, to any Member which made a Member Loan in the amount (b) Then, to the Members in an amount equal to the sum of the credit balances of their respective Contribution Accounts, in the ratio that the credit balance of each Contribution Account bears to the sum of the credit balances of all Contribution Accounts. (c) The balance, if any, to and among the Members in accordance with their respective Ownership Percentages. HOU02:

10 Example 3 Distributions of Net Cash Flow and Sale and Financing Proceeds 7.7 Distribution of Net Cash Flow. The Net Cash Flow from the business operations of the Partnership (as defined in Section 7.3), shall be distributed to the Partners on a quarterly basis as follows: (a) First, to the Partners in repayment of loans to the Partnership by the Partners pursuant to Section 3.4 (including accrued and unpaid interest thereof) in proportion to the relative amounts owed to each Partner; (b) Second, to the Preferred Return Partner to the extent of the accrued and unpaid Preferred Return owed to it; (c) Third, to the Preferred Return Partner to the extent of the accrued and unpaid Accumulated Preferred Return owed to it; and (d) Finally, to the Partners in the proportions of their respective Ownership Interests. To the extent any distributions to any Partner under this Section 7.7 are subject to withholding under any applicable provision of the Code, such Partner hereby grants to the General Partner the authority to so withhold as the General Partner deems necessary in its discretion; it being the understanding and agreement of the Partners that withholding shall only be made out of the share of the Partner which is subject to such withholding. 7.8 Distribution of Sale Proceeds and Financing Funds. In the event of a refinancing of Partnership assets or a sale of Partnership assets which does not result in a dissolution of the Partnership pursuant to Article VIII hereof, the Sale Proceeds (as defined in Section 7.3) and Financing Funds (as defined in Section 7.3) from such sale or refinancing shall be distributed when available to the Partners in the following priorities: (a) First, to the Partners in repayment of Loans to the Partnership by the Partners pursuant to Section 3.4 (including accrued and unpaid interest thereof) in proportion to the relative amounts owed to each Partner; (b) Second, the Preferred Return Partner to the extent of the accrued and unpaid Preferred Return owed to it; (c) Third, to the Preferred Return Partner to the extent of the accrued and unpaid Accumulated Preferred Return owed to it; HOU02:

11 (d) Fourth, to the Preferred Return Partner to the extent of the excess of (i) the amount contributed by it pursuant to Section 3.1, over (ii) the amount distributed to it pursuant to this Section 7.8(d); and (e) Interests. Finally, to the Partners in the proportions of their Ownership To the extent any distributions to any Partner under this Section 7.8 are subject to withholding under any applicable provision of the Code, such Partner hereby grants to the General Partner the authority to so withhold as the General Partner deems necessary in its discretion; it being the understanding and agreement of the Partners that withholding shall only be made out of the share of the Partner which is subject to such withholding. HOU02:

12 III. TAX DISTRIBUTIONS HOU02:

13 Example 4.7. Tax Distributions. The Partnership shall distribute to each Partner, within 90 days after the end of each taxable year of the Partnership, cash in amounts, which when added to the distributions made to such Partner after the formation of the Partnership, will equal or exceed the amount of federal, state and local income tax (taking into account, for such purposes, each Partner s distributive share of the credits of the Partnership which are available for federal, state or local income tax purposes) payable solely by reason of such Partner s distributive share, within the meaning of Section 704(b) of the Code, of the income, gain, loss and deductions of the Partnership or by reason of any amount which is required to be included in such Partner s income by reason of Section 707(c) of the Code, assuming for such purposes, that (i) any such income and gain reduced by losses and deductions attributable to the Partner by reason of his interest in the Partnership is subject to federal, state and local income tax at the maximum rate applicable to any person with a taxable year equal to the calendar year without reduction for other deductions or credits and (ii) the distributive share of any unused deductions and losses of the Partnership of the Partner may be carried forward. The General Partner shall also cause the Partnership to make distributions from time to time during a taxable year of the Partnership (which shall be treated as an advance of the amounts distributable pursuant to the preceding sentence with respect to the taxable year) of amounts required by each Partner to make payments of estimated taxes for federal, state or local income tax purposes. Any amount distributed to a Partner pursuant to this Section 4.7 shall reduce the amount which such Partner is otherwise entitled to receive thereafter pursuant to Sections 4.4, 4.5 and 7.4. HOU02:

14 IV. HURDLES AND PREFERRED RETURNS HOU02:

15 Example 1 Preferred Return Generally 7.2 Preferred Return. Commencing with the date hereof, the Preferred Return Partner shall be entitled to receive from the Partnership a return (the APreferred Return@) on the amount of such Partner=s Outstanding Capital Contribution (as defined below) at a rate equal to nine percent (9%) per annum. To the extent that the Partnership has Net Cash Flow, Sales Proceeds or Financing Funds, the Preferred Return shall be paid quarterly in cash. To the extent that the Partnership does not have Net Cash Flow, Sales Proceeds or Financing Funds sufficient to pay the Preferred Return when due, the Preferred Return shall compound annually at nine percent (9%) per annum and shall accumulate (AAccumulated Preferred Return@). AOutstanding Capital Contribution@ shall mean the excess of (i) the aggregate amount of a Partner=s Initial Capital Contribution pursuant to Section 3.1, over (ii) the aggregate amount previously distributed to such Partner pursuant to Section 7.8(d). HOU02:

16 Example 2 Definition of IRR Internal Rate of Return shall mean the internal rate of return calculated on an effective annual compounding basis based on the timing and amount of all Capital Contributions of the Managing Member and distributions of Company Cash Flow and Covered Sale Transaction Proceeds to the Managing Member. The internal rate of return is a discount rate that makes the net present value of these cash flows equal to zero, without regard to federal, state or local income tax consequences. In determining the Internal Rate of Return, the following shall apply: (i) the Internal Rate of Return calculation shall be applied to monthly cash flow periods; and (ii) the Internal Rate of Return shall be calculated using the following formula in Microsoft Excel: (1+IRR(monthly array of cash flows, guess))^12-1. HOU02:

17 Example 3 Definition of IRR SCHEDULE I Calculation of Unleveraged Internal Rate of Return The term Internal Rate of Return means a non-modified internal rate of return which equals the discount rate that equates (a) the present value of the cash received by Partner with respect to the Project to (b) the present value of the Project Costs expended by Partner. For the purposes of calculating such Internal Rate of Return: (i) Project Costs shall be deemed to be made on the last day of the month in which they were actually expended by Partner; (ii) Cash receipts shall be deemed to be received on the last day of the month in which such cash is actually received by Partner; (iii) The proceeds of financing used to pay Project Costs shall be treated as amounts expended by Partner, and the cash receipts that are used to pay principal and interest on such financing shall be treated as cash received by Partner; and (iv) The number of periods to be used in calculating the Internal Rate of Return shall be the number of months occurring during the period which commences on the date as of which the initial Project Costs are expended by Partner and ending with (and including) the month during which the calculation is made. HOU02:

18 V. PARTNER-PARTNERSHIP TRANSACTIONS HOU02:

19 Example 1 Guaranteed Payments Section 7.01 Guaranteed Payments. The Partnership shall make Guaranteed Payments to the Class A Limited Partners as provided in this Section without regard to the Partnership s income. The Guaranteed Payments are intended to be treated as guaranteed payments as that term is used in Section 707(c) of the Code. (a) Guaranteed Payment Amount. No later than the last day of each Fiscal Year, the Partnership shall pay each Class A Limited Partner a Guaranteed Payment which is equal to the Partner s Class A Preference Return plus any balance in the Partner s Class A Preference Account. (b) Allocation of Deduction. Any deduction for federal income taxes which is attributable to a Guaranteed Payment shall be allocated among the Partners in accordance with Article VI and Exhibit A. (c) Failure to Pay for Two Years. If the Partnership fails to make any of the Guaranteed Payments required by this Section for two consecutive Fiscal Years, the Class A Limited Partners shall have the power, exercisable only by majority consent determined on the basis of the combined balances in each Class A Limited Partner s Class A Contribution Account and Class A Preference Account, (i) to remove the Managing Partner, if any, and (ii) whether or not there is a Managing Partner at the time, to appoint one or more of the General Partners to serve as Managing Partner of the Partnership. If all of the General Partners have been removed by the Class A Limited Partners under the authority of this subsection, the Class A Limited Partners may elect a new General Partner in the same manner. The remedy provided by this subsection shall be the sole remedy available to the Class A Limited Partners for the Partnership s failure to make Guaranteed Payments. No Class A Limited Partner nor any other person shall have any right to maintain a lawsuit or proceeding in any court against the Partnership or any of the Partners seeking to require the Partnership to make Guaranteed Payments or seeking damages for the Partnership s failure to make Guaranteed Payments. HOU02:

20 Example 2 Disguised Sale Tax Treatment. The Parties intend and expect that the transactions contemplated by this Agreement will be treated, for purposes of federal income taxation and for purposes of certain state income tax laws that incorporate or follow federal income tax principles, as resulting in (a) the creation of the Company, in which the Property Partner and the Money Partner will be treated as partners, (b) subject to clause (d) below, a contribution by the Property Partner of all of the Contributed Interests to the Company in exchange for a 50% interest therein; (c) a contribution by the Money Partner of the Final Cash Amount to the Company in exchange for a 50% interest therein; and (d) a distribution by the Company to the Property Partner of the Final Cash Amount (i) as a reimbursement of the Property Partner s preformation expenditures with respect to the Contributed Interests within the meaning of Treasury Regulations Section (d) to the extent applicable, and (ii) in a transaction subject to treatment under Section 707(a) of the Code, and its implementing Treasury Regulations, as in part a sale, and in part a contribution, by the Property Partner of the Contributed Interests to the Company to the extent Treasury Regulations Section (d) is inapplicable. HOU02:

21 VI. LIQUIDATION MECHANICS HOU02:

22 Example 1 Liquidation in Accordance with Capital Accounts (a) Liquidating Trustee; Liquidating Distributions. Upon dissolution of the Company, the Board (in such capacity, the Liquidating Trustee ) shall carry out the winding up of the Company and shall immediately commence to wind up the Company s affairs; provided, however, that a reasonable time shall be allowed for the orderly liquidation of the assets of the Company and the satisfaction of liabilities to creditors so as to enable the Members to minimize the normal losses attendant upon a liquidation. The proceeds of liquidation shall be applied first to payment of all expenses and debts of the Company and setting up of such reserves as the Board reasonably deems necessary to wind up the Company s affairs and to provide for any contingent liabilities or obligations of the Company; provided that the unpaid principal of and interest on any loans made to the Company by Members (and their Affiliates) shall be distributed pro rata to the Members (and their Affiliates) who made such loans, in proportion to the total amount of principal and interest payable on such loans, such distributions being treated first as a payment of accrued interest on such loans and next as in payment of principal on such loans. Any remaining proceeds shall be distributed to the Members in accordance with their respective Capital Account balances. (b) Profits and Losses. The Profits and Losses arising from liquidation of the Company shall be allocated among the Members so that, to the maximum extent possible, each Member s Capital Account balance equals the amount of cash that would be distributed to such Member if liquidating distributions were made in accordance with Section 8.2. HOU02:

23 Example 2 Liquidation in Accordance with Ownership Percentages 11.2 Liquidation. (b) Upon the dissolution of the Partnership, the liquidating trustee shall sell the Partnership assets at the best price available, or, with the consent of all Partners, the liquidating trustee may distribute those assets in kind; provided, however, that the liquidating trustee shall ascertain the fair market value by appraisal or other reasonable means of the Partnership assets to be distributed in kind, and each Partner s Capital Account shall be charged or credited, as the case may be, as if such asset had been sold for cash at such fair market value and the net gain or net loss recognized thereby had been allocated to and among the Partners in accordance with Article VI above. All of the Partnership assets shall be applied and distributed, with reference to the fair market value thereof, by the liquidating trustee on or before the later to occur of (x) the end of the taxable year in which the dissolution of the Partnership occurs, (y) the date that is 90 days following the date upon which substantially all of the Partnership assets are sold or otherwise disposed of by the Partnership, or (z) the date that is 90 days following the date any other event of dissolution occurs, and in the following order: (i) First, to the creditors (other than the Partners with respect to Partner Loans) of the Partnership; (ii) Next, to setting up the reserves that the liquidating trustee may deem reasonably necessary for contingent or unforeseen liabilities or obligations of the Partnership; (iii) Next, to the Partners in an amount equal to the sum of the credit balances of their respective Partner Loan Accounts, in the ratio that the credit balance of each Partner Loan Account bears to the sum of the credit balances of all Partner Loan Accounts; (iv) Next, to the Partners in an amount equal to the sum of the credit balances of their respective Contribution Accounts, in the ratio that the credit balance of each Contribution Account bears to the sum of the credit balances of all Contribution Accounts; (v) Finally, the balance, if any, to and among the Partners in accordance with their respective Ownership Percentages. HOU02:

24 VII. ALLOCATIONS HOU02:

25 Example 1 Forced Allocations Section 5.1 Allocations of Net Income or Net Loss. Except as provided in Section 5.2, and subject to Section 5.3, for purposes of maintaining the Capital Accounts the Company s items of Net Income and Net Loss shall be allocated among the Members in a manner such that the Adjusted Capital Account of each Member, immediately after making such allocations is, as nearly as possible, equal (proportionately) to the distributions that would be made to such Member pursuant to Section 5.4 if the Company were dissolved, its affairs wound up and its assets sold for cash equal to their Book Basis, all Company liabilities were satisfied (limited with respect to each nonrecourse liability to the Book Basis of the asset securing such liability), and the net assets of the Company were distributed in accordance with Section 5.4. HOU02:

26 Example 2 Service Partner Allocations Section 7.2. Allocations of Net Income and Net Loss. (a) Net Income for each year shall be allocated to the Partners (1) in their Post-Payout Percentages to the extent that the Net Income adds to a Cumulative Net Income and (2) in their Percentage Interests to the extent that the Net Income reduces a Cumulative Net Loss. (b) Net Loss for each year shall be allocated to the Partners (1) in their Post- Payout Percentages to the extent that the Net Loss reduces a Cumulative Net Income and (2) in their Percentage Interests to the extent that the Net Loss increases a Cumulative Net Loss. (c) These allocations will be adjusted to take into account any adjustments to the Percentage Interests and to the Post-Payout Percentage Interests pursuant to Section 6.2, Section 6.7, Section 9.1(d), Section 9.4 and Section 9.5 of this Agreement.... Cumulative Net Income means the excess of (i) the aggregate Net Income allocated in all years pursuant to Section 7.2(a), over (ii) the aggregate Net Loss allocated in all years pursuant to Section 7.2(b). Cumulative Net Loss means the excess of (i) the aggregate Net Loss allocated in all years pursuant to Section 7.2(b), over (ii) the aggregate Net Income allocated in all years pursuant to Section 7.2(a). Post-Payout Percentages means 80% to the Money Partner and 20% to the Service Partner. Pre-Payout Percentages means 100% to the Money Partner and 0% to the Service Partner. HOU02:

27 Example 3 Waterfall Allocations 8.4 Allocations of Net Profit and Net Loss. Except to the extent required by Section 704 of the Code, Net Profit and Net Loss shall be allocated as follows: (a) Net Profit for each Period shall be allocated as follows: (i) First, to each of the Members in proportion to and to the extent of the excess of (x) the aggregate amount of Net Loss allocated to such Member pursuant to Section 8.4(b)(v) for all prior Periods over (y) the aggregate amount of Net Profit allocated to such Member for all prior Periods pursuant to this Section 8.4(a)(i); (ii) Second, to each of the Members in proportion to and to the extent of the excess of (x) the sum of (A) the excess of the Initial Leveraged IRR Hurdle of such Member over the aggregate amount of Capital Contributions of such Member and (B) the aggregate amount of Net Loss allocated to such Member for all prior Periods pursuant to Section 8.4(b)(iv) over (y) the aggregate amount of Net Profit allocated to such Member for all prior Periods pursuant to this Section 8.4(a)(ii); (iii) Third, 70% to the Preferred Partner and 30% to the Common Partner until the aggregate amount of Net Profit allocated pursuant to this Section 8.4(a)(iii) for the current Period and all prior Periods is equal to the sum of (x) the excess of (A) the 11% Leveraged IRR Hurdle over (B) the sum of the Initial Leveraged IRR Hurdles of the Members and (y) the aggregate amount of Net Loss allocated to the Members for all prior Periods pursuant to Section 8.4(b)(iii); (iv) Fourth, 60% to the Preferred Partner and 40% to the Common Partner until the aggregate amount of Net Profit allocated pursuant to this Section 8.4(a)(iv) for the current Period and all prior Periods is equal to the sum of (x) the excess of (A) the 15% Leveraged IRR Hurdle over (B) the 11% Leveraged IRR Hurdles of the Members and (y) the aggregate amount of Net Loss allocated to the Members for all prior Periods pursuant to Section 8.4(b)(ii); and Partner. (v) Fifth, 55% to the Preferred Partner and 45% to the Common (b) Net Loss for each Period shall be allocated as follows: (i) First, to the Members in proportion to and to the extent of the excess of (x) the aggregate amount allocated pursuant to Section 8.4(a)(v) for all prior Periods, over (y) the aggregate amount allocated to the Members pursuant to this Section 8.4(b)(i) for all prior Periods; (ii) Second, to the Members in proportion to and to the extent of the excess of (x) the aggregate amount allocated pursuant to Section 8.4(a)(iv) for all prior HOU02:

28 Periods, over (y) the aggregate amount allocated to the Members pursuant to this Section 8.4(b)(ii) for all prior Periods; (iii) Third, to the Members in proportion to and to the extent of the excess of (x) the aggregate amount allocated pursuant to Section 8.4(a)(iii) for all prior Periods, over (y) the aggregate amount allocated to the Members pursuant to this Section 8.4(b)(iii) for all prior Periods; (iv) Fourth, to each of the Members in proportion to and to the extent of the excess of (x) the aggregate amount allocated pursuant to Section 8.4(a)(ii) for all prior Periods over (y) the aggregate amount allocated to the Members pursuant to this Section 8.4(b)(iv) for all prior Periods; and (v) Fifth, to each of the Members in proportion to the aggregate amount of Capital Contributions of such Member. The allocations in this Section 8.4 shall be adjusted to account for any adjustments in the Percentage Interests and adjustments of the other percentages in Section 3.5(a)(ii)(1). HOU02:

29 Example 4 Allocations in Proportion to Ownership Section 9.1. Profits and Losses. After giving effect to the special allocations set forth in Section 9.2 and 9.3 and subject to the allocations contained in Section 13.4(b), all Profits and Losses from operations and items thereof for each Fiscal Year (or part thereof), shall be allocated among the Members in proportion to their relative Membership Interests. HOU02:

30 VIII. CAPITAL ACCOUNTS HOU02:

31 Example 1 Section 4.6 Capital Account Mechanics. (a) A separate Capital Account shall be established and maintained for each Member in accordance with the requirements of Treasury Regulations Section (b)(2)(iv). The original Capital Account established for any Member who acquires Membership Interests by virtue of an assignment in accordance with the terms of this Agreement shall be in the same amount as and shall replace the Capital Account of the assignor of such Interest. To the extent such Member acquires less than all of the Membership Interests of the assignor of the Membership Interests so acquired by such Member, the original Capital Account of such Member and its Capital Contributions shall be in proportion to the Membership Interests it acquires, and the Capital Account of the assignor who retains any Membership Interests shall be reduced in proportion to the Interest it retains. (b) The Capital Account of each Member shall be maintained in accordance with the following provisions: (i) to such Member s Capital Account there shall be credited such Member s Capital Contributions, such Member s distributive share of Profits, special allocations of income and gain, and the net amount of any Company liabilities that are assumed by such Member or that are secured by any Company assets distributed to such Member; (ii) to such Member s Capital Account there shall be debited the amount of cash and the Gross Asset Value of any Company assets distributed to such Member pursuant to any provision of this Agreement, such Member s distributive share of Losses, special allocations of loss and deduction, and the net amount of any liabilities of such Member that are assumed by the Company or that are secured by any property contributed by such Member to the Company; (iii) in determining the amount of any liability for purposes of this Section 4.6(b), there shall be taken into account Section 752(c) of the Code and any other applicable provisions of the Code and the Treasury Regulations; and (iv) the Capital Accounts shall be increased or decreased upon a revaluation of Company property pursuant to clause (b) of the definition of Gross Asset Value in the manner prescribed in Treasury Regulation Section (b)(2)(iv)(f). HOU02:

32 Example 2 Gross Asset Value and Depreciation Gross Asset Value means, with respect to any asset, such asset s adjusted basis for federal income tax purposes, except as follows: (a) the initial Gross Asset Value of any asset contributed by a Member to the Company shall be the gross fair market value of such asset, as agreed to by the contributing Member and the Board; (b) the Gross Asset Value of all Company assets shall be adjusted to equal their respective gross fair market values, as determined by the Board, in connection with: (i) the acquisition of an additional interest in the Company by any new or existing Member in exchange for more than a de minimis Capital Contribution or in exchange for the performance of services to or for the benefit of the Company; (ii) the distribution by the Company to a Member of more than a de minimis amount of Company assets as consideration for an interest in the Company; (iii) the liquidation of the Company within the meaning of Treasury Regulations Section (b)(2)(ii)(g) (other than pursuant to Section 708(b)(1)(B) of the Code); and (iv) the grant of an interest in the Company (other than a de minimis interest) in consideration for the provision of services to or for the benefit of the Company or any other event to the extent determined by the Board to be necessary to properly reflect the Gross Asset Values in accordance with the standards set forth in Treasury Regulations Section (b)(2)(iv)(q); provided, however, that adjustments pursuant to clause (i) and clause (ii) of this sentence shall be made only if the Board reasonably determines that such adjustments are necessary or appropriate to reflect the relative economic interests of the Members in the Company; (c) the Gross Asset Value of any Company asset distributed to any Member shall be the gross fair market value of such asset on the date of distribution, as determined by the Board and the distributee Member; and (d) the Gross Asset Values of Company assets shall be adjusted to reflect any adjustments to the adjusted basis of such assets pursuant to Code Section 734(b) or Code Section 743(b), but only to the extent that such adjustments are taken into account in determining Capital Accounts pursuant to Treasury Regulations Section (b)(2)(iv)(m). If the Gross Asset Value of an asset has been determined or adjusted pursuant to paragraph (a) or paragraph (b) above, such Gross Asset Value shall thereafter be adjusted by the Depreciation taken into account with respect to such asset for purposes of computing Profits and Losses..... Depreciation means, for each Fiscal Year or other period, an amount equal to the depreciation, amortization or other cost recovery deduction allowable for federal income tax purposes with respect to an asset for such Fiscal Year as determined by the Members; provided, however, that if the Gross Asset Value of an asset differs from its adjusted basis for federal HOU02:

33 income tax purposes at the beginning of such Fiscal Year or other period, Depreciation for such Fiscal Year or other period shall equal to the amount of book basis recovered for such Fiscal Year or other period under the rules prescribed by Treasury Regulation Section (d)(2) and provided further, that if the federal income tax depreciation, amortization or other cost recovery deduction for such Fiscal Year or other period is zero, Depreciation shall be determined with reference to such beginning Gross Asset Value using any reasonable method selected by the Members. HOU02:

34 IX. REGULATORY ALLOCATIONS HOU02:

35 Example Section 9.2 Special Allocations. Notwithstanding anything in this Agreement to the contrary, the following special allocations shall be made: (a) Nonrecourse Deductions. Nonrecourse Deductions for any taxable year shall be allocated to the Members in proportion to their relative Membership Interests. (b) Member Nonrecourse Deductions. Member Nonrecourse Deductions for any taxable year shall be allocated 100% to the Member that bears the Economic Risk of Loss with respect to the Member Nonrecourse Debt to which such Member Nonrecourse Deductions are attributable in accordance with Treasury Regulation Section (i). If more than one Member bears the Economic Risk of Loss with respect to a Member Nonrecourse Debt, Member Nonrecourse Deductions attributable thereto shall be allocated between or among such Members in accordance with the ratios in which they share such Economic Risk of Loss. This Section 9.2(b) is intended to comply with the provisions of Treasury Regulation Section (i) and shall be interpreted consistently therewith. (c) Company Minimum Gain Chargeback. Notwithstanding any other provision of this Agreement, if there is a net decrease in Minimum Gain during any taxable year, each Member shall be allocated items of Company income and gain for such year (and, if necessary, subsequent taxable years) in the manner and amounts provided in Treasury Regulation Sections (f)(6), (g)(2) and (j)(2)(i). For purposes of this Section 9.2, each Member s Capital Account shall be determined, and the allocation of income or gain required hereunder shall be effected, prior to the application of any other allocations pursuant to this Article 9 with respect to such taxable year. This Section 9.2(c) is intended to comply with the partner minimum gain chargeback requirement in Treasury Regulation Section (f) and shall be interpreted consistently therewith. (d) Member Nonrecourse Debt Minimum Gain Chargeback. Notwithstanding the other provisions of this Agreement (other than Section 9.2(c) above), if there is a net decrease in Member Nonrecourse Debt Minimum Gain during any taxable year, any Member with a share of Member Nonrecourse Debt Minimum Gain at the beginning of such taxable year shall be allocated items of Company income and gain for such year (and, if necessary, subsequent taxable years) in the manner and amounts provided in Treasury Regulation Section (i)(4) and (j)(2)(ii). For purposes of this Section 9.2, each Member s Adjusted Capital Account balance shall be determined, and the allocation of income and gain required hereunder shall be effected, prior to the application of any other allocations pursuant to this Article 9, other than Section 9.2(c) above, with respect to such taxable year. This Section 9.2(d) is intended to comply with the partner nonrecourse debt minimum gain chargeback requirement in Treasury Regulation Section (i)(4) and shall be interpreted consistently therewith. (e) Qualified Income Offset. Except as provided in Sections 9.2(c) and 9.2(d) above, in the event any Member unexpectedly receives an adjustment, allocation or distribution described in Treasury Regulation Sections (b)(2)(ii)(d)(4), (5) or (6), items of Company income and gain shall be allocated to such Member in an amount and manner sufficient to eliminate, to the extent required by such Treasury Regulation, the deficit balance, if any, in its HOU02:

36 Adjusted Capital Account created by such adjustment, allocation or distribution as quickly as possible unless such deficit balance is otherwise eliminated pursuant to Sections 9.2(c) or 9.2(d). This Section 9.2(e) is intended to constitute a qualified income offset described in Treasury Regulation Section (b)(2)(ii)(d) and shall be interpreted consistently therewith. (f) Gross Income Allocation. In the event any Member has a deficit balance in its Adjusted Capital Account at the end of any taxable year, such Member shall be allocated items of Company gross income and gain in the amount of such excess as quickly as possible; provided, however, that an allocation pursuant to this Section 9.2(f) shall be made only if and to the extent that such Member would have a deficit balance in its Adjusted Capital Account after all other allocations provided in this Section 9.2 (other than Section 9.2(e)) have been tentatively made as if Section 9.2(e) and this Section 9.2(f) were not in this Agreement. Section 9.2 Curative Allocations. The allocations set forth in Section 9.2 (the Regulatory Allocations ) are intended to comply with certain requirements of the Treasury Regulations. It is the intent of the Members that, to the extent possible, all Regulatory Allocations shall be offset either with other Regulatory Allocations or with special allocations of other items of Company income, gain, loss or deduction pursuant to this Section 9.3. Therefore, notwithstanding any other provision of this Article 9 (other than the Regulatory Allocations), but subject to the Code and the Treasury Regulations, the Board shall make such offsetting special allocations of Company income, gain, loss or deduction in whatever manner it determines appropriate so that, after such offsetting allocations are made, each Member s Capital Account balance is, to the extent possible, equal to the Capital Account balance such Member would have had if the Regulatory Allocations were not part of this Agreement. In exercising its discretion under this Section 9.3, the Board shall take into account future Regulatory Allocations that, although not yet made, are likely to offset other Regulatory Allocations previously made.... Adjusted Capital Account means the Capital Account maintained for each Member (a) increased by any amounts the Member is obligated to contribute or restore to the Company pursuant to the penultimate sentences of Treasury Regulations Sections (g)(1) and (i)(5), and (b) decreased by any amounts described in Treasury Regulations Sections (b)(2)(ii)(d)(4), (5), or (6) with respect to such Member. HOU02:

37 X. INCOME TAX ALLOCATIONS HOU02:

38 Example 1 Income Tax Allocations and Remedial Allocations Section 9.4 Income Tax Allocations. (a) Except as provided in this Section 9.4, each item of income, gain, loss and deduction of the Company for federal income tax purposes shall be allocated among the Members in the same manner as such items are allocated for book purposes under Sections 9.1, 9.2 and 9.3. (b) In accordance with Code Section 704(c) and the applicable Treasury Regulations thereunder, income, gain, loss and deduction with respect to any property contributed to the Company shall, solely for tax purposes, be allocated among the Members so as to take account of any variation between the adjusted basis of such property to the Company for federal income tax purposes and its Gross Asset Value at the time of its contribution to the Company. If the Gross Asset Value of any Company property is adjusted in accordance with clause (c) or (d) of the definition of Gross Asset Value, then subsequent allocations of income, gain, loss and deduction shall take into account any variation between the adjusted basis of such property for federal income tax purposes and its Gross Asset Value as provided in Code Section 704(c) and the related Treasury Regulations. For purposes of such allocations, the Company shall elect the remedial allocation method described in Treasury Regulation Section (d), and the Members shall jointly make all other decisions required of the Partnership under Treasury Regulation Section (d). (c) All items of income, gain, loss, deduction and credit allocated to the Members in accordance with the provisions hereof and basis allocations recognized by the Company for federal income tax purposes shall be determined without regard to any election under Section 754 of the Code which may be made by the Company. (d) If any deductions for depreciation or cost recovery are recaptured as ordinary income upon the Transfer of Company properties, the ordinary income character of the gain from such Transfer shall be allocated among the Members in the same ratio as the deductions giving rise to such ordinary character were allocated. HOU02:

39 Example 2 704(c) with No Specificity Section 704(c). Items of income, gain, loss and deduction with respect to property that has a Gross Asset Value that is different from its adjusted tax basis shall, for tax purposes only, be allocated among the Partners in the manner provided under Section 704(c) of the Code and Treasury Regulations thereunder so as to take into account any variation between the basis of the property to the Partnership and its fair market value at the time of contribution. Any elections or other decisions relating to such allocations shall be made by the General Partners in any manner which reasonably reflects the purposes and intention of this Agreement. HOU02:

40 XI. TAX AUDIT PROVISIONS HOU02:

41 Example Standard provision: Tax Matters Partner. The General Partner shall be the tax matters partner of the Partnership, within the meaning of Section 6231(a)(7) of the Code and any regulations issued thereunder, unless the Code or the regulations issued thereunder require another person to be the tax matters partner. The expenses, if any, that the General Partner incurs in fulfilling its covenants pursuant to this Section shall be expenses of the Partnership. The following addition should be made if your client is not the tax matters partner: As tax matters partner, the General Partner covenants and agrees with the Limited Partner that (i) after the receipt of a final partnership administrative adjustment for a taxable year, the General Partner will not file a petition for readjustment of the partnership items, within the meaning of Section 6226 of the Code, in any court other than the United States Tax Court, without the consent of the Limited Partner and (ii) the General Partner will not agree, pursuant to Section 6229(b)(1)(B) of the Code, to extend the period for assessing any tax imposed by subtitle A of the Code with respect to any person which is attributable to any partnership item (or affected items) of the Partnership without the consent of the Limited Partner. HOU02: