Demystifying Gifts Involving LLCs

Transcription

1 Demystifying Gifts Involving LLCs NCPP October 2017 Bill Knox, Director, Planned Gift Technical Consulting

2 Selected Forms of Business Organization By U.S. Tax Return Filed Limited Liability Companies (LLCs) 0.75 million 1.8 million 2.1 million 2.4 million S Corporations 2.7 million 4.0 million 4.2 million 4.3 million C Corporations 2.1 million 1.9 million 1.6 million 1.6 million Source: Tax Statistics of the Internal Revenue Services ( 1

3 Million Number of Partnership Returns by Entity Type By U.S. Tax Return Filed for Tax Years Domestic general partnership Domestic limited partnership Domestic limited liability partnership Source: Tax Statistics of the Internal Revenue Services ( 2

4 Million Number of Partners in LLCs by Entity Type By U.S. Tax Return Filed for Tax Years Domestic general partnership Domestic limited partnership Domestic limited liability partnership Source: Tax Statistics of the Internal Revenue Services ( 3

5 Why are C Corporations So Popular? Limits the liability of all shareholders Two levels of federal income taxation Corporate Shareholder Unlimited owners/ ease of transferability 4

6 So, Why an S Corporation? Avoid the double taxation of C corporations Limit the liability of all members May claim losses personally 5

7 Alright, What About Those LLCs? Avoid the double taxation of corporations Limit the liability of all members Offer more flexibility than S corps 6

8 Investment Portfolios Real Estate Variety of Assets in LLCs Businesses 7

9 Challenges Associated with Gifts Involving LLCs 8

10 Complexity Tax pitfalls Transferability 9

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12 LLC Flow Chart Diagram 100% Disregarded Entities LLCs 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 < > No > or < 50% of Profits and Capital Transferred in last 12 months CGA Technical Termination Tax free New tax election New accounting method Yes CRT May Not Own S Corp. Outright or CGA C Corp. UBTI Publicly Traded Closely Held Restrictions on Transfer Self Dealing Concerns Qualified Appraisal Unit holder Is this permissible distribution rules of LLC? Split Interest Gifts for LLC Income flow through to unit holders according to distribution rules economic effect Employee Compensation Possible withholding 100% ordinary income Outright Passive Active UBTI Substantially all? 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 11

13 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? 12

14 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 13

15 LLCs Units Business Activities Assets 14

16 Does the Donor Own 100% of Units? Yes No Disregarded Entity Partnership 15

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19 Substantially all UBTI S Corporation CRT prohibition Limited deduction 18

20 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 19

21 The Players Houses, LLC 65% ownership 35% ownership 20

22 LLC Units Business Activities Assets 21

23 Does the Donor Own 100% of Units? Yes No Disregarded Entity Partnership 22

24 Gift Strategy LLC Units LLC Units Buyer Recognition and Deduction Payment 23

25 Sources of Liquidity Buy-Sell Agreements Valuation Issues Deduction Issues UBTI 24

26 Sources of Liquidity LLC unit redemption Third party buyers Other individual unit holders 25

27 Buy-Sell Agreements Allowable shareholders Terms of Sale ROADMAP BUY-SELL AGREEMENTS Sale Price Caution Issues Ahead 26

28 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 27

29 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 28

30 Deduction Issues: Hot Assets Unrealized receivables Highly appreciated inventory Deduction is reduced by ordinary income under Sec. 751(a) 29

31 Unrelated Business Taxable Income On active trades or businesses Debt gives rise to UBTI Top corporate tax rate: 35% Charitable trust tax rate: 100% 30

32 Outcome LLC Units LLC Units Buyer Recognition and Deduction Payment 31

33 Differences with S and C Corporations Sources of Liquidity Buy-Sell Agreements Valuation Issues Deduction Issues Uber UBTI UBTI 32

34 S Corporation Über UBTI Rules On ALL items of income Debt gives rise to UBTI Top corporate tax rate: 35% CRTs prohibition 33

35 A Better Gift Strategy Outright Gift by S Corp of S Corp Asset S Corp Asset Charity Charity Recognition and Deduction 34

36 Another Gift Strategy Cash S Corp Shares Cash Third Party Recognition and Deduction Charity Charity Buyer 35

37 Comparison of Options Charity taxed on income of business Capital gain Donor Gives S Corp Shares S Corporation Gives Assets* Donor Sells and Gives Cash Yes No No Taxed to charity up to 35% None Taxed to donor at 15% Qualified appraisal Yes Maybe No Valuation discounts Yes No No Hot asset rules Yes No No AGI deductibility limit 30% 30% / 50% 50% *Other taxes might apply if the S corporation was previously a C corporation, or if a corporation gives away substantially all of its assets. 36

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39 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 38

40 LLCs Units Business Activities Assets 39

41 How Is the LLC Taxed? Partnership Corporation Non- Taxable Distribution Taxable Distribution 40

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43 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? 42

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45 203 Redwood Shores Parkway, Suite 300 Redwood Shores, CA Phone: (650) One Metropolitan Square 211 North Broadway, Suite 1000 St. Louis, MO Phone: (314) Franklin Street, 7th Floor, Boston, MA Phone: (617) and prior years by Kaspick & Company, LLC, a registered advisor and provider of advisory services. This presentation may not be reproduced, distributed, or transmitted in any form, in whole or in portion, by any means, without written permission from Kaspick & Company, LLC.