Introduction To Partnerships And LLCs. GAO Report--Large Partnerships: Growing Population and Complexity Hinder Effective IRS Audits (July 22, 2014)

Transcription

1 Introduction To Partnerships And LLCs GAO Report--Large Partnerships: Growing Population and Complexity Hinder Effective IRS Audits (July 22, 2014)

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3 GAO Report--With Growing Number of Partnerships, IRS Needs To Improve Audit Efficiency (Sept. 18, 2014) Commissioner Koskinen Statement on Oct 17: "Our position is the most significant thing we can do to break that bottleneck [is to] amend [the law] and say we can audit a partnership."

4 Entities Taxed Like a Partnership 1-5 JCT 2015 Choice of Entity Analysis

5 General Partnership (GP) G Ptr Alice Unlimited 50% 50% G Ptr Bill Unlimited AB GP Limited Partnership (LP) G Ptr Alice Unlimited 50% 50% L Ptr Bill Limited AB LP

6 Limited Partnership (LLP) Alice Ltd. Except Malpractice 50% 50% AB LLP Architecture Bill Ltd. Except Malpractice Limited Company (LLC) Alice Limited 50% 50% Bill Limited Over 50% of All Partnerships AB LLC

7 S Corporation Alice Limited 50% 50% AB S Corp. Bill Limited G Ptr G Ptr SMLLC Alice Unlimited Limited L Ptr Bill 50% 50% Limited AB LP

8 G Ptr Limited With SMLLC/GP G Ptr Alice SMLLC Limited L Ptr Bill 50% 50% Limited AB LP G Ptr Limited Alice 100% GP Ptr S Corp. Limited 50% 50% AB LP L Ptr Bill Limited

9 Limited Limited Partnership (L3P) G Ptr Alice Ltd. in some states 50% 50% LP Bill Ltd. AB L3P L3P In California G Ptr SMLLC Alice Unlimited Limited L Ptr Bill 50% 50% Limited AB L3P

10 G Ptr Limited G Ptr Alice SMLLC Limited L Ptr Bill 50% 50% Limited AB L3P Series Limited Company (SLLC) Alice Limited 50% 50% Series LLC Bill Limited

11 State of California attributes of each of these entities: FTB Publication Partnership vs. Tenants in Common

12 mere co-ownership of property that is maintained, kept in repair, and rented or leased does not constitute a separate entity for federal tax purposes. (Reg (a)(2)) 1-11 The furnishing of customary services in connection with the maintenance and repair of the apartment project will not render a coownership a partnership (Rev. Rul ) 1-11

13 With rental real estate, TIC co-owners can rely upon Rev. Rul to qualify for a section 1031 exchange of the ownership interest 25 Landlord (via agent): negotiates and executes leases collects rents pays taxes, assessments, and insurance premiums performs all maintenance and repair work

14 Customary tenant services, such as heat, air conditioning, hot and cold water, unattended parking, normal repairs, trash removal, and cleaning of public areas are furnished by the landlord. Not a partnership (even if a T or B). (Rev. Rul ) TIC Rev. Proc No More than 35 Persons The co-owners must retain the right to approve: the hiring of a manager, sale of the property lease of the property *** 1-12

15 Partner and LLC Member Self- Employment Income The Safest Method? When is a partner a limited partner and thus eligible for the section 1402(a)(13) exclusion from SE tax? 30

16 Easy Answer: State Law Limited Partners 31 Tougher Question: What about LLC members or LLP members? 32

17 LLP Income Is SE Income In Renkemeyer An LLP Law Firm The Taxpayer argument focused on the limited liability of LLP members and that similarity to a limited partner 34

18 Judge Jacobs ignored the prop. regs. which have never been finalized. The prop. regs. deny limited partner status for legal services 35 The court was left to interpret the statute (section 1402(a)(13)) 36

19 Renkemeyer Conclusion: The section 1402(a)(13) exclusion was aimed at earnings of an investment nature rather than compensation for legal services 37 Investment Service Partners' LLC Income Subject to Self-Employment Tax CCM (Sept 5, 2014) 38

20 A B LLC (originally an S Corp) Fees GP Mgt LP LP Services LP LP LP LP LP Trading/ Investing Funds -- LPs The partners were paid small guaranteed payments similar to the W-2 wages they received as S shareholders -- reasonable compensation. 40

21 The K-1s did NOT characterize the partners distributive share as SE income (LLC issued W-2s characterizing some as wages) 41 IRS cited Renkemeyer and Reither: The partners, service partners, are not limited partners; therefore, they are subject to SE tax 42

22 Reither cited Rev. Rul for the rule that partners are not employees of the partnership" for SE purposes (W-2s are inappropriate) 43 Joint Venture is a Partnership Notwithstanding Election out of Subchapter K Methvin v. Comm r T.C. Memo (April 27, 2015) 44

23 Section 761(a) Election out of Subchapter K If availed of --: (1) For investment only and not an active T or B. (2) Joint production, extraction, or use of property, or (3) By dealers in securities for a short period The issue was the applicability of selfemployment tax to the investor/taxpayer s 2% to 3% working interests in oil and gas ventures. 46

24 Oil and gas joint ventures in which the owners, by agreement, elected to be excluded from subchapter K. 47 Taxpayer argued: (1)No T or B and (2)The election out of Subchapter K protected the taxpayer from SE tax. 48

25 Both taxpayer arguments failed 49 T or B via agents operating the business on the taxpayer s behalf 50

26 A partnership remains a partnership, and thus the earnings are subject to SE tax per section 1402(a) 51 The election out only prevents the application of subchapter K (Secs ) 52

27 Consider a rental real estate co-ownership in which the owners elect out of Subchapter K and make the election by filing form 1065 (instead of by agreement) 53 Section 1031 is not in Subchapter K However 54

28 With a sec. 761 election out, the partnership interest is treated as an interest in each asset of the partnership for section 1031 purposes (sec. 1031(a)(2) flush language) 55 Rago Development Corp (April 24, 2015) Swap and Drop California SBE held that taxpayer qualified for 1031 even though taxpayer transferred ( dropped ) the Ch. 2 replacement property into an LLC/partnership seven months after the exchange ( swap ) 56

29 Could the Methvin ventures have avoided SE tax as LLCs? 57 Limited Company (LLC) Methvin Limited 2% 98% Oil and Gas LLC Others Others Limited

30 If the ventures were LLCs, and Methvin a nonmanaging member 59 A Limited Partner per the 1997 Prop Regs

31 A Category One Limited Partner Unless: 1) Personal liability by reason of being a partner; OR 2) Authority to contract under state LLC law; OR 3) Participates over 500 hours during tax year. (Reg. Sec (a)-2(h)(2)) 61 A limited partner so no SE tax NIIT Potential (passive T or B) 62

32 What if LLC member Methvin were a nonmanging member, but he participates over 500 hours? No SE Tax per Category Three of the Prop. Regs. (no NIIT a nonpassive T or B) 63 Category Three Ltd. Ptr. Over 500 hours, but Category One LPs own substantial (20% or more) in his class of LLC interest, and His rights and obligations are the same as the LPs. (Reg. Sec (a)-2(h)(4)) 64

33 What if LLC member Methvin were a Manging member and participates over 500 hours? He is not a limited partner for that LLC interest, so SE tax applies 65 But what if Methvin also owns another class of LLC interest that is identical to the other nonmanaging members who are LPs under Category One 66

34 With respect to the separate class of LLC units (nonmanaging member units) 67 Category Two Ltd. Ptr. Holds more than one class of partnership interest. Is treated as a Ltd. Ptr. with respect to a specific class of interest. Other Ltd. Ptrs. own a substantial continuing interest in that class. The individual s rights and obligations are identical to those held by the Ltd. Ptrs. (Reg. Sec (a)-2(h)(3)) 68

35 Together, these rules exclude from an individual's net earnings from self-employment amounts that are demonstrably returns on capital invested in the partnership Prop. Reg. Preamble 69 Should also work for a limited partnership interest owned by a general partner provided sufficient other LPs (what Treasury had in mind) 70

36 But why was Methvin s oil and gas joint venture likely not organized as an LLC? 71 Section 469(c)(3) makes oil and gas working interest losses nonpassive regardless of taxpayer participation But 72

37 Not per se nonpassive if the oil and gas entity limits the owner s liability 73 Can the investment service partners in CCM (Sept 5, 2014) somehow qualify for limited partner status under the Prop. Regs.? 74

38 A B LLC (originally an S Corp) Fees GP Mgt LP LP Services LP LP LP LP LP Trading/ Investing Funds -- LPs A service partner in a service partnership is expressly not a limited partner under the proposed regs. 76

39 A service partnership is a partnership substantially all the activities of which involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, or consulting 77 So if A and B want to minimize SE tax, what should they do? 78

40 A B LLC (originally an S Corp) Fees GP Mgt LP LP Services LP LP LP LP LP Trading/ Investing Funds -- LPs Convert the LLC Back to an S Corp or C corp. Granted, reasonable compensation must be paid and the salaries are subject to FICA 80

41 A AB S Corp. Fees Mgt GP LP LP LP Services LP LP LP LP B Trading/ Investing Funds -- LPs Appendix A Links to All Partnership Tax IRC Sections and Related Treasury Regulations

42 IRC Section and Title 701. Partners, not partnership, subject to tax 702. Income and credits of partner Regulation Section Regulation Heading Partners, not partnership, subject to tax Anti-abuse rule Income and credits of partner Net operating loss deduction of partner t 4-Year spread (temporary). Appendix B IRS Partnership Audit Techniques Guide 1-42