Watching Out for the Blind Spots of Partnership Tax Vehicles

Watching Out For the Blind Spots ofPartnership Tax Vehicles

© 2009 T. Scott Tufts, Esq.

September 23, 2009



INTRODUCTION

2


The Pass-Through EntitiesYour vehicle of choice?

Joint Venture

General P’ship

LLP LLLP

Limited P’ship

(Ltd.)

Member-Managed

LLC

Manager-Managed

LLC

S Corporation????

Single-Member LLC

3


Full Speed Ahead……

…and don’t look back?

LLPLLC

LLLP

4


Partnerships at Formation…..

Partner

Member #1

Partner

Member #2

Limited Liability Entity

5


….can end up in the courtroom

What “Promises” Were Made?

What “Promises” Were Broken?

Who Gets What?

6


….and you might find yourself rightin the middle!!!!

7


Whistleblowers & SAR/OX

8


Divorce Disclosures

Financial

Disclosure

Statement

IRS FORM 8857

Innocent

Spouse

Protections

9


Policing the Highways

10


CAN YOU REALLY FLY BELOW THE IRS’RADAR SCREEN?............

IRS

Taxpayer &his/her law firm

Credit Card Summons

IRS Form 8886 (TaxShelters & More)

Foreign Bank A/C(Sch. B, F.1040)

Informant Rewards(Form 211 & K w/ US)

No More SecrecyOffshore

IRS Form 8082 (K-1Matching Program)

11


........WHEN THE GOVERNMENT IS IN SEARCH OFREVENUES?

IRSIssuing IDRs

toTax Shelter

Participants!

IRS KnowsThat Complex

P’ship StructuresOften Times

Is a Tax Shelter

12


LLP LLCLLLP

THE NEW & IMPROVEDIRS’ K-1 MATCHING PROGRAM

Man. GP GP Manager

Partner LimitedPartners

Member Member

Partner

K-1 K-1 K-1K-1

K-1

K-1

13


Radar Guns & Speed Traps

• List Maintenance & IRS Summons’– Disclosure of Clients Engaged in Potentially

Abusive Tax Shelters– Case Law: Can’t protect one’s identity under the

attorney-client privilege (or 7525 tax practitionerprivilege)

• IRS Form 8886• Offshore Credit Card Program• Informant Reward Program (NEW)• SAR/OX & Whistleblower Claims• Innocent Spouse Claims (Ratting Out Your

Spouse, While Protecting Yourself)

14


Part I

Overview of the LLP,LLC and LLLP Entity

(and Other Entity Options)

15


The Choice Of Entity Menu

• Corporation

– “C” Corporation

– “S” Corporation

• Limited Liability Company(LLC)

– Member-managed

– Manager-managed

– Single-Member/Tax Nothing

– Multiple-Member

– Bankruptcy Remote

– FLLCs

• Sole Proprietorship

• Branch/Division

• Limited Partnership(RULPA)(Ltd.)

– w/Corp. GP?– New: “LLLP” (GP-Safe?)– FLPs

• General Partnership (RUPA)

– Regular

– Joint Venture

– New: LLP

• Local Trusts (Spendthrift)

• Business Trust (Delaware)

• Florida Land Trust

• REITs (QRS; TRS; PSS)

• REMIC; FASIT; TMP

• Domestic Protection Trusts(Delaware, Alaska, Nevada, RhodeIsland, etc.)

• Foreign Trusts (Offshore)

– The “Affordable Media” Problem &the Offshore Credit Cards

– Schedule B/Disclosure Issues

16


• F.S. Sec. 608.701: “In any case in which a party seeks to hold themembers of a LLC personally liable for the liabilities or allegedimproper actions of the LLC, the court shall apply the case lawwhich interprets the conditions and circumstances under which thecorporate veil of a corporation may be pierced under the law of thisstate.”

– Dania Jai-Alai Palace, Inc. v. Sykes, 450 So.2d 1114 (Fla.1984)(no veil piercing unless LLC was organized or used to misleadcreditors or work a fraud upon them)

– Courts favorable compare Florida’s shield to Delaware

• And, still strong…for e.g., U-CAN-II, INC. v. Setzer (11/26/03)

– Watch Out! Patin-piercing; de facto merger, mere continuation,successor liability theories

– Watch out….even in Delaware, shields can be pierced….., andundercapitalization is an indicator of “bad motive”

LLCStatutory Adoption ofCorporate Piercing of the VeilStandard

17


LLPSomething New To Think About…

The Florida Limited Liability Partnership

(F.S. Sec. 620.9001 et.seq.)

“An obligation of a partnership while the partnershipis a LLP, whether arising in contract, tort, orotherwise, is solely the obligation of the partnership.A partner is not personally liable, directly orindirectly, by way of contribution or otherwise, forsuch an obligation solely by reason of being or soacting as a partner.” F.S. Sec. 620.8306(3)

18


LLLPAnd, ……what about…

The Florida Limited Liability Limited Partnership

(F.S. Sec. 620.187)(RULPA)

“A limited partnership may become a LLLP by: (1)obtaining approval; (2) filing a Statement ofQualification; and (3) complying with the namerequirements.”

Section 620.8306(3) of RUPA shall apply to bothgeneral and limited partners of a LLLP such that “anobligation of a partnership while the partnership is aLLLP, whether arising in contract, tort, or otherwise,is solely the obligation of the partnership. A partner,whether limited or general, is not personally liable,directly or indirectly, by way of contribution orotherwise, for such an obligation solely by reason ofbeing or so acting as a partner” in a LLLP.

19


• Getting Started (Same as C Corporation)– Except: IRS FORM 2553 (“S Election”)

• Lots of Nitpicky Rules:– Domestic (U.S. only)

– # of Shareholders: No more than 75

• U.S. citizens/residents; estates; certain trusts only

• NO corporations, partnerships, LLCs, etc.

• 501(c)(3); 401 qualified plans now permitted (but UBTI!)

• Beneficial Owners

– Single Class of Stock (Voting/Nonvoting: OK)

• NO Preferred Stock

• Watch Out for Warrants, Options, etc.

S Corporation

20


General Partnership(Florida’s Revised Uniform Partnership Act Of 1995)

…..With All Partners Jointly And Severally Liable For AllObligations Of The Partnership (See F.S. Sec. 620.8306(1)),…..Why Would We Ever Form One Of These?……………….

21


Limited Liability Company(LLC; LC; L.L.C.; L.C.)

2 Basic Types

Member-ManagedLLC

Manager-ManagedLLC

General P’ship

Model

Ltd. P’ship

Model

Corp-like Shield

Corp-like Shield

Corp-Like P’ship-Like

22


Sole Proprietorship(Schedule C)

23


Single-Member LLCs

SINGLE-MEMBERLLC

BANKRUPTCY REMOTELLC

Tax Nothings, but “Real” Entities Under State Law

Member: 100%

Member:100%

(Tax Purposes)

24


SINGLE MEMBERLLC

?Creditors

Piercing of the Veil Standard?FTC v. Olmstead (Florida Supreme Court)

25


What About……………?• Delaware DP Trust

– Will these really work?

– How much?

• Alaska Trusts

– See Delaware

– Do you have family there?

• Business Trusts

– IRS: “These are abusive”

• Land Trusts

– Transparent for tax purposes

• “Pure” Trusts (Tax Evasion?)

• Foreign Trusts (USA Patriot Act;Disclosure Issues)

• REIT/QRS/TRS (fancy)

• FASIT/REMIC (fancy)

• Del. LLC Series LLC Structures

26


Making the “Right” Choice...

• Who is the client?

• Business/activity/service?

• Business Assets?

• # of owners?

• Going public?

• Duties owed (loyalty, care, fair dealing, good faith)

• Tax issues

• Liability Piercing of the Veil?

• “Convertibility”

• Clarity of law

27


……but not the “Wrong” Choice

• At-Risk Rules of LLEs

• Foreign R/E Investment

– Estate Tax Bomb

– Use of U.S. Corp Subs.

• C or S Corp-----MERGE------>LLC

– For tax purposes: liquidation ofCorp, followed by recontributionof assets to LLC

• Multistate Tax Issues

– Woops! Tenn/Texas tax LLCslike Corps. (as Fla used to do)

– Woops! Some States do notrecognize fully-shielded LLPs orSingle-Member LLCs

28


……but not the “Wrong” Choice

• Family Estate Planning

– No “discounts” for FLLP; ButFLP/FLLC?

– 2036 (Eff. Control) Problem

– A Business Purpose? A Gift?

• S Corp. Shareholder Problem

– Inadvertent Termination (IneligibleShareholders (e.g., foreign owners,corps, p’ships, etc.)); certain Trusts

• Active Business/Payroll Issues

– LLC/LLP= Seca Tax (15.3%; 2.9% x>$80,400 in 2001)

– S Corp = Dist’Ns not subject toSECA/SS Tax (not yet); only on wages

• Business Trust = P’ship vs. tax nothing(Corp-w/election)

• Florida Land Trust =Corp/P’ship/Trust/Nothing

• Foreign Trust = Sham/Abusive?29


Getting Sloppy with the Purported DRE/SPE

• Evaluating HybridFinancing—The TaxIssues

– Equity Kickers(Interest Enhancers):Is lender de factopartner?

• Convertible DebtInstruments

• Options

• Shared AppreciationMortgages

• Irrevocable Lines of Credit

• Demand Notes

TaxPandemonium

If Equity, then….

NEW: Prop.Regs.-Noncomp. Options

with Anti-Abuse Rule!!!!!

Let theReallocationsBegin!!!!!

30


The Dangers of a “Push-the-Button” Mentality

31


Part II

Understanding the Partnership TaxVehicle

Not Quite What You MightThink

32


The Modern Era (1996-present)(New Check-the-Box Regulations (December 18, 1996)

• New, step-by-step approach:– Is the entity one that will be recognized as an entity under

federal law?

• Not merely co-owners (w/o services)

• No Sham Entities (Formed solely to avoid taxes)

– Is it a “business entity” or really a trust, etc.?

• Trusts (merely to hold and conserve)

• If not a trust, then go forward in your analysis

– Is “business entity” foreign or domestic?

• If foreign, is it on per se’ corporation list

• Look to see if in existence as of 1/1/97/status claimed

– If not foreign, then may elect “p’ship” status (if more than onemember) or have entity disregarded (if only one member);otherwise, classified as corporation (unless all members don’thave limited liability)

33


A TEFRA Blind Spotfor an Actually Blind Taxpayer

HUDSPATH v. COMMISSIONER, T.C.Memo 2004-75

Can this beFair?

TEFRA

34


Part III

Watching for the Blind Spotsin Entity Selection

35


Making the “Right” Choice...

• Who is the client?

• Business/activity/service?

• Business Assets?

• # of owners?

• Going public?

• Duties owed (loyalty, care, fair dealing, good faith)

• Tax issues

• Liability Piercing of the Veil?

• “Convertibility”

• Clarity of law

36


BLIND SPOTS IN ENTITY SELECTIONWhen a Delaware LLC May be the Wrong Choice?

• Delaware LLCs:– No distinction made under the LLC Act between member-

managed and manager-managed– This raises the possibility that all members are presumptive

managers, and therefore, subject to SECA tax

• Compare, in Florida,– Affirmatively state in articles of organization whether

or not manager-managed LLC• Watch out! if your Articles of Organization do not specify

whether LLC is member-managed or manager-managed(or, at least, until operating agreement confirms type)

• This is because under Florida’s LLC Act, assumption ismade that entity will be a member-managed LLC, unlessotherwise provided in its articles of organization oroperating agreement and in a member-managed LLC, eachmember is an agent of the LLC

37


Part IV

Watching for the Blind Spotsin Entity Formation

38


BLIND SPOTS IN FORMATIONTHE RISK OF OPERATING W/O A WRITTEN AGREEMENT

Articles ofOrganization

Auth.Rep.:

Mr. CPA

1997

CPA

Columbus Bar Ass’n v. Verne, 788 NE 2d 1064 (Ohio 2003)

LLC Formed by CPA

Bus. Man #1

Bus. Man #2

“You Don’t Need aLawyer When

Making Choice ofEntity Decisions”

“(CPA) drafted articles oforganization, using formsavailable from the Sec. ofState’s office as abaseline, to establish thebusiness as a LLC”

39


BLIND SPOTS IN FORMATIONTHE RISK OF OPERATING W/O A WRITTEN AGREEMENT (con’t)

“Partners” have a falling out

1999-2000

Angry partner goes to lawyer, whoreviews documents and discovers thatno operating agreement had beenexecuted.

Sup.Ct. of Ohio: “…an omission that commentators cautionagainst” ……”.‘written operating agreements minimize disputes,prevent fraud, protect the legitimate expectations of the members,and avoid or minimize problems with disregard of the entity forliability purposes.’” citing to H&M, Ohio LLC Forms and PracticeManual (Dec. 2001).

Lawyerthen files aUPLgrievancewithColumbusBar Ass’n

40


BLIND SPOTS IN FORMATIONTHE RISK OF OPERATING W/O A WRITTEN AGREEMENT (con’t)

CPA’s Lawyer Argues:

“As a CPA, he iscapable of competentlyadvising clients in thecreation of thesedocuments.”

CPA’S LAWYER TO THE JUDGE:“ISN’T THE FILING OF ARTICLES OF

ORGANIZATION MERELY A CLERICALSERVICE?????”

Court: No. “For a layperson to draft documentscreating a business entity on another’s behalf isunquestionably the unauthorized practice of law.” citing,Florida Bar v. Mills, 398 So.2d 1368 (Fla. 1981)”

Mills: Florida Supreme Court: “drafting of articles ofincorporation is the practice of law.” citing to Fuentes,Keehley, Town

41


BLIND SPOTS IN FORMATION (cont’d)THE RISK OF OPERATING W/O A WRITTEN AGREEMENT

“While we recognize that CPAs perform a valuable function in advising on financialmatters in the formation of a company, such as how best to structure a business entityfor tax benefits, there are still many remaining issues that require legal analysis inchoosing a business structure. This case highlights the dangers when those lines areblurred. In this case, (the CPA) helped his clients choose a business structure, adecision that ordinarily requires a significant amount of legal judgment in addition totax and other accounting considerations. Clients need to know the legal differencesbetween and formalities of available structures, and then be advised according to theirbest interests, taking into account personal and practical concerns, not just taxconsequences. Where there is more than one principal involved in the venture,the existing and potential conflicts also must be assessed. This undertaking ishardly the clerical service that (CPA) insists he performed…(his) advice to hisclients about which business structure they should choose is…the unlicensedpractice of law.”

The Result in Verne: UPL Violation

42


BLIND SPOTS IN FORMATIONTHE RISKS OF OPERATING W/O A WRITTEN AGREEMENT

– What About Florida?

– Commentators:

• “Organizers of LLCs should not delay the execution of theoperating agreement beyond the consummation of anytransactions involving the LLC, including acceptance ofcapital contributions to the LLC, since the operatingagreement generally will be necessary to establish therelative rights, authority, powers and duties of themanager(s) or managing members and of the membersinter se, matters which typically are not covered in thearticles of organization.” Cohn & Ames, Fla.Bus.LawsAnn., 2002-2003, at 383-384 (emphasis added).

POSSIBLE SOLUTION: Section 608.423 of the Fla LLC Act:

HAVE MEMBERS ENTER INTO AGREEMENT BEFORE THE FILING OFARTICLES, WHICH “TAKES EFFECT” UPON THE FILING OF THE ARTICLES

43


Blind Spots in FormationThe Failure to Properly Advise with Respect to

Capital Contributions!!

“But, YourHonor….,

the CPA told methat I could simply

leave the“Schedule A”

blank!

McLeod v. Jackson, 829 So.2d 722 (Miss.Ct.App. 2002)

44


Blind Spots in FormationService Providers & Contribution Obligations

• “The CATCH 22” for Service Providers!!!!

– “Profits-Only Interests”• (Speculative Value-& Non-Taxable)

vs.– “Capital Interests”

• (Agreed Value & Taxable)

– Florida LLC Act:• Default-based Right of a LLC to “Liquidate”

Property or Service Contribution Obligation IntoCash

45


BLIND SPOTS IN FORMATIONOverlooking the Importance of Capitalization and the

Prefunding Process:How To Do It?

Estate of Stone

Start of Negotiations

P’ship

Agreement

Draft

P’ship

Agreement

Rev.

Draft

CapitalContribution.

Agreement

Rev.

Draft

Family and Lots of Lawyers

FLP/FLLC

Start of Business

46


BLIND SPOTS IN FORMATIONOverlooking the Importance of Capitalization and the

Prefunding Process:How Not To Do It?Estate of Hillgren

FLP/FLLC

Start of Business

1/1/1997

Lawyer for the Deal

Mr.Hillgren Ms.Hillgren/Estate

P’ship

Agreement

Effective“as of”

1/1/1997No Written Oper. Agreement

UntimelyDeath

No Negotiations

47


BLIND SPOTS IN FORMATIONOverlooking the Importance of Capitalization –

Family Estate PlanningHow Not To Do It?

Heckerman v. IRS (W.D.Wash. 2009)

FAMILYLLC

CHILD TRUST-1

CHILD TRUST-2“SAME DAY”

48


BLIND SPOTS IN FORMATION

FINANCIAL PLANNER’S E-MAIL (10/9/2001)Heckerman v. IRS (W.D.Wash. 2009)

"....when you place your funds into the LLC, no gift is being made (andtherefore, no utilization of your unified credit). At that time, effectivelyyou own 100% of an entity that now owns the $4 million of assets you

have contributed. The gift for IRS purposes is made when you giftownership in the LLC to the kids or their trusts. For example, say youput $4,000,000 into the LLC. Immediately after, you own 100% of theLLC. You may then choose to gift 25% of the ownership of the LLC

(not a gift of the assets the LLC holds) to each of the kids. Since weare using the LLC (and the resultant discounts), even though the

combined 50% of the assets is $2,000,000, for gift taxes the IRS onlyconsiders the gift to be of $1,350,000. This gift of the LLC ownership is

where you and your spouse's $675,000 exemptions are used. To getthe remaining ownership of the LLC to your kids or their trusts, youwill make gifts of LLC ownership equal to $20,000 (again grossed up

for the discounts) to each child every year.“ (emphasis added)

49


BLIND SPOTS IN FORMATIONWorking with Single-Member LLCs

Pierre v. IRS, 133 T.C. No. 2 (8/24/2009)

SingleMember

LLC

SON’S TRUST

GC’S TRUST

SEC

Transfers to beValued as Transfers

of Interests(DiscountsApply)!!!!

50


BLIND SPOTS IN FORMATIONCAPITAL ACCOUNT MAINTENANCE RULES

& WORKING WITH “AGREED VALUE” CONCEPTS

PROPERTY OWNINGTRUST

LANDDEV. LLC

DEVELOPER

50%

Capital Contribution

REAL ESTATE

AB Agreed Value

Rural. R/E * *

Beach R/E * *

Total $1.7 mil $1.2 mil.1.2 mil.

50% + Pref. Ret.on sales, at agreedvalue

SERVICES

ISSUE: IS THEIRS BOUND BYWHAT THEPARTIES LISTAS “AGREEDVALUE”?

Low-Ball State Court: FMV of Appraisals:$2,500,000

51


BLIND SPOTS IN FORMATION (cont’d)CAPITAL ACCOUNT MAINTENANCE RULES


PROPERTY OWNINGTRUST

LANDDEV. LLC

DEVELOPER


REAL ESTATE

1. “reasonably agreed to”?

2. arm’s-length negotiations?

3. sufficiently adverseinterests?

4. overstated/understated bymore than an insignificantamount?

REGS. 1.704-1(b)(2)(iv)(h)

“For purposes of the C/A maintenance rulesunder 704(b), the fair market value assigned toproperty contributed to a p’ship…will beregarded as correct, provided that: (1) suchvalue is reasonably agreed to among thepartners in arm’s-length negotiations, and (2) thepartners have sufficiently adverse interests. If..not, …and the value assigned to such propertyis overstated or understated (by more than aninsignificant amount), the capital accounts of thepartners will not be considered to have beendetermined and maintained in accordance with”704(b).

52




HOUSTON PIPE LINE CO.

HPLASSET

HOLDINGS, Ltd.(Del. LP)

ENRON CORP.


Bammel Assets

AB Agreed Value

Total $30 mil $930 mil.930 mil.

BammelAssets

99.89% LP

.01% GP$1mil

.1%

LP

Leasebackfor 18 years

Elects: Remedial Method(704(c))

cash

Enron-affiliate

53


BLIND SPOTS IN FORMATION (cont’d)


HPLASSET


ENRON CORP.

99.89% LP .01% GP

.1%

LP

Elects: Remedial Method(704(c))

SMLLC

WhitewingLP

Pref.LP

OSPREY INVESTORS

BammelAssets

SMLLC

Allocate 100%of Deprec.to Enron

Recoverdep. Using150% dec.,over 15 yrs

TaxStrategy:

DistributeBammel

Assets backto HPL after16 years, inredem. of

its LP

54





HPLASSET


ENRON CORP.

Testing “Agreed Values”Capital Contributions

of Property

1. “reasonably agreed to”?

2. arm’s-lengthnegotiations?

3. sufficiently adverseinterests?

4. overstated orunderstated by morethan an insignificantamount?

Capital ContributionBammel Assets

AB Agreed Value

Total $30 mil $930 mil.930 mil.

BammelAssets $1

mil .1%

LP

JCT Enron Rep’t: (2003) “…Enron did not obtain an appraisal of the BammelAssets…and ascribed a value of approx. $930 mil. ..for purposes of Sec.704(c). In 2001, …an internal Enron memo surfaced, valuing these assets at$460 mil. Because no independent appraisal was done…it is not clearwhether the value …declined by 50% or whether the original valuation …wasgrossly overstated to maximize the tax benefits of” this project.”

THESE PARTIES ARE AFFILIATED…….

55


BLIND SPOTS AT FORMATIONWHEN DOES LIFE BEGIN FOR YOUR TAX P’SHIP?

Cert ofLtd.

P’ship

Filed

9/2/82

MapleVillageP’ship

(purch/oper shop. ctr)

$90

Mr. Robert Johnston

90%GP

Initial Limited Partner

$10

10% LP

Conf. Private PlacementMemorandum

40 Units offered for sale at$200,000/unit (2.475% LPinterest per unit), via N/Pand $11,750 down

GP will make nocapital contribution, butwill own 1% of the capital,profits, and losses of entity

GP will receive aone-time org. feeof $30,000

ExclusiveRight toManage

INVESTORS

$$$(escrow)

ClosingDec.1982

56


BLIND SPOTS IN FORMATIONWHEN DOES LIFE BEGIN FOR YOUR TAX P’SHIP?

MapleVillage

Ltd. P’ship

ClosingDec.1982 Purchase of Shopping

Center Location

$12 million$600,000 down

mtg. $11.4

Capital:$470K

$7.5 millionN/P

Bank

Leased to: Orig. Corp.Sponsor

Eccelston Prop., Ltd.

Man. Fee ($)

Dec. 31, 1982Dec. 31, 1982

Partner CapCont %

GP $ 90, +serv. 1.0

LP Inv. $8 million 99.0

IRS: Cap. Shift—FMV $80,808

Johnston v. IRS, T.C.Memo 1995-166 (findingcapital shift and assessing neg. penalties)

P’ship Begins for Tax Purposes

57


BLIND SPOTS AT FORMATIONWHEN OSTENSIBLE SELLERS WANT TO BECOME

PARTNERS WITH THEIR BUYERS

GAF CHEMICALSCORP.

(G-I Holdings, Inc.)

Rhone-PoulencSurfactants &

Specialties, LP

RHONE-POULENC

SURFACTANTS &SPECIALTIES, INC.

GP

LP

$26 MillionEquity Stake1990 “721”

ALKARIL CHEMICALS,Inc.

Given the right to retire 98% ofGAF’s p’ship interest, but only afterexpiration of 3-year TAXDISGUISED SALE RULE PERIOD

McKee, Nelsonissues tax opinion

letter.This “should” work!!

58


BLIND SPOTS IN FORMATIONWHEN T-IN-C OWNERS ARE “TAX” PARTNERS

• Rev. Proc. 2002-22 (procedures for obtaining IRS ruling that undividedfractional interest in R/E is not a p’ship)

– Co-owners’ activities must be limited to those customarilyperformed in connection with m’nance & repair of rental R/E

– See PLR 2003-27003 (no use of “common name”; no tax p’ship)

• Making the 761 election out of Subchapter K?????

• Watch out for trusts that do more than merely protect and conserveproperty—can be classified as a p’ship!! Cf. Rev.Rul. 79-77 (trust-ok)

59


BLIND SPOTS IN FORMATION

WHEN T-IN-C OWNERS ARE “TAX” PARTNERS

Co-Owner No. 1 Co-Owner No. 2

Tax Returns (Form 1065) Filed?

Title to R/E Taken AsTenants-in-Common

Assume: No Representationsof State Law P’ship

..... Don’t Worry, Be Happy????

Filing ofTax ReturnMay “Estop”Taxpayer!!

Representationsof JV/P’ship

In F/S May “Estop”Taxpayer!

60


BLIND SPOTS IN FORMATIONOIL AND GAS & THE SECA TAX FOR GRANNY

• Court: “We find that, because(Ethyle) was obligated under(oil & gas agreement) tomanage and operate her owninterests, she was engaged inthe business of producing andselling gas…Whether (Ethyle)was personally involved inoperating the business or usedthe services of an agent oremployee to achieve that endmakes no difference; the netincome realized therefromretains its character as self-employment income.”

Ethyle Moorhead v. IRS,T.C.Memo 1993-314

Ethyle, 92:

“I’m too old, merely passive owner.Not self-employed.”

61


Blind Spots in FormationFarm Rents & the SECA Tax

Johnson v. Comm’r,T.C.Memo 2004-56

Solvie v. Comm’r,T.C.Memo 2004-55

Rents Not Tiedto Production

Rents Tied toProduction

62


BLIND SPOTS IN FORMATIONAgreements to Purchase, Renovate & Sell R/E:

A “Tax” Joint Venture in Disguise?

• Podell v. IRS, 55 T.C. 429 (1970)

– Lawyer & R/E Operator shared profits on sales: 50/50

– Purchase, renovation, and sale = tax p’ship

– R/E “held for sale” and therefore, sales not eligible for CG

– Ordinary income (trade or business income)

DOCTOR

$$$R/E Operator

To purchase, renovate residential R/E

Provide actual management of project

---Practicing full-time

R/E Sales

Passive??

50/50Profits

63


Blind Spots in Formation:Alliances

Auditor Independence

64


Blind Spots in FormationAccommodation Parties

Tax-Neutral Tax-Motivated

65


Blind Spots in FormationAccommodation Parties in Action?

Tax Efficiency or Abusive Tax Planning?

BILLIONAIREBANKER BEAL

CINDA’S USALLC SUB

66


BLIND SPOTS AT FORMATIONSOUTHGATE MASTER FUND, LLC

(N.D. TEX 2009)

SOUTHGATEMASTER FUND, LLC

MARTELASSOCIATES, LLC

TMP

$1.1 BILLION NONPERFORMING

LOANS INCHINA

CINDA’S USASUB LLC

99%

1%

19000 Obligors SpreadOut All Over China

24,000 Distressed Asset LoansSHIFTING $1.1`BILLION BUILT-IN

LOSSBILLIONAIREBANKER BEAL

FMV: $19.4 MILLION?

$100,000

67


BLIND SPOTS IN FORMATIONNEW CASE LAW DEVELOPMENT

SOUTHGATE MASTER FUND, LLC v. U.S. (N.D.Tex. 8/21/09)

– Partnership vehicles used by sophisticated banker to purchaseChinese NPLs, that court found were NOT worthless

– Partnership vehicle used to accomplish Southgate transactionwas a genuine busIness deal, generating $216 million inlosses, but……………

– Another partnership tax vehicle arose that was nothing morethan a sham to gain tax benefits for banker

– Court rejects US Govt’s “basis killer” arguments, but……– Transaction pursued to increase Beal’s OB lacked economic

substance and violated step transaction doctrine, aspartnership tax vehicle was a sham

– No penalties applied, because legal advice given by qualifiedCPAs and tax attorneys and good faith efforts were made tocomply with black-letter law, with due diligence

68


BLIND SPOTS IN FORMATIONNEW CASE LAW DEVELOPMENT

Murfam Farms, LLC v. U.S. (Ct of Fed.Claims 8/3/09)

– “Basis Killer” Regs. Section 1.752-6 cannot be used, to applyretroactively, in contingent liability cases

– Plausible for transaction at issue to have economic substancebecause of Sala, 552 F.Supp.2d 1167, 1199 (Col. 2008)

– Sala holds for proposition that a Treasury Regulation thatconflicts with underlying statute is invalid, even if cast as ananti-abuse regulation

– Could taxpayers reasonably rely on Helmer line of cases to findthat options are excluded from calculation of a partner’s basisin the partnership

– Statutory bar on retroactive application under IRC Sec. 7805(b)applies (Govt has shown that any exceptions apply).

• Disagrees with:– Cemco Investors, LLC v. US, 515 F.3d 749 (7th Cir. 2008)– Maguire Partners-Master Invs, LLC v. US, 2009 WL 279100 (C.D.Cal. 2009)

69


BLIND SPOTS IN FORMATION“BARE BONES, NO MEAT”

WHEN THE PUBLIC CAN’T TELL WHAT TYPE OF ENTITY YOU ARE &WHO’S IN CHARGE

• Member-Managed or Manager-Managed Limited LiabilityCompany?

• Authorized Representative, But of Whom?

• Who’s in Charge?– Actual Authority

– Apparent Authority

– Implied Authority

• EZ Auto, L.L.C. v. H.M., Jr. Auto Sales, 2002 WL 1758315(Tex.App. 2002)(LLC designated as manager-managed LLC in itsarticles and naming Marks named as initial manager; becauseMarks was not dispossessed of the belief that he could “bind” theentity, LLC bound by transaction he entered into as the manager,despite efforts to remove him).

70


Part V

The Blind Spots of Not Knowing

What the IRS Is Looking For

71


The Blind Spots of Not Knowing

What the IRS Is Looking For

TheMSSP

TaxShelters

TaxReturns

72


• IRS Exam Techniques—Misallocations ofBasis—Negative Capital Accounts

BLIND SPOTS – Not KnowingWatching Out for Audits Triggered by K-1 Matching Re:

Allocations of Debt

Schedule K-1—Capital Accounts (Form 1065 Tax Returns)

This Partner is a: __ GP ___ LP ___ LLC Mem. Partner’s Share of Liabilities:

What type of entity is the partner: ______ Nonrecourse: 10,000

Is this partner a ___ domestic or ___ foreign partner? Qualified NR: _______

Enter partner’s % of: Before Ch./Term End of Yr. Other: _______

Profit Sharing ____ % ____ % Tax Shelter Reg. : ______

Loss Sharing ____ % ____ % Check if publicly traded: ___

Ownership of Capital ____ % ____ % Check: _ Final K-1 _ A K-1

Cap.at Beg. Cap.Cont. Income W/D/Dist’n Cap at End

1992 12,000 -0- 33,000 70,000 (25,000)

73


BLIND SPOTS – Not KnowingWatching Out for Audits Triggered by K-1 Matching Re:

Allocations of Debt

Ehrensperger v. IRS, T.C.Memo 1994-279

Taxpayer failed to show that he wasentitled to greater amount of partnershiplosses than allowed by IRS.

Taxpayer only presented Form 1065 &Schedules K-1 for each, when requested toshow his share of liabilities

TAX COURT: SCHEDULES K-1 ALONEARE NOT SUFFICIENT TO ESTABLISHSHARE OF LIABILITIES.

CONSIDER WHETHER BURDEN OFPROOF CHANGES UNDER SECTION7491 MAY BE OF ASSISTANCE NOW

74


IRS in Search of Big Wins

75


Market Segment Specialization Program

Practitioners

MSSPGuide

Agents /Examiners

76


• IRS Examination Technique– “Sometimes a partnership will attempt to avoid TUFTS gain on

disposition of property by sale or foreclosure by claiming that theliability…still exists. Without relief of liability, no gain is requiredto be recognized.

– Partnerships which are no longer actively engaged inbusiness but which still wander aimlessly about sheddingtax benefits or postponing gain are called “ZOMBIEPARTNERSHIPS.”

– Look for Partnerships/LLCs with:

• Debt

• Large Negative Capital Account

• Few assets/little activity (or negative assets and no debts)

BLIND SPOTS – Not KnowingIs your Partnership a “Zombie Partnership”?

77


BLIND SPOTS – Not KnowingIs Your Client an “Unidentified Partner” Needing

Protection Under TEFRA?

SourceP’ship

John DoeFamily Trust

Beneficiary

Pass-ThruLLC

Mary Doe Bill Roe

Unidentified Partner? TEFRA Unidentified Partners?

K-1 K-1

K-1

K-1K-1

F.8082?

F.8082?

78


• Basis Overstatements are Not Omissions (no 6-year S/L)

• Special Statute of Limitations Applies to a TEFRA P’ship

– Section 6229• Transpac Drilling Venture 1983-2 v. U.S., 83 F.3d 1410 (Fed.

Cir. 1996)

– Though formed for improper purposes, TEFRA partnershiprespected as such for purposes of TEFRA

– “Partner” (TMP) signing FALSE tax returns, even though heknew that false losses would only benefit other partners

– Special Section 6229(c) statute applies: NO SOL for partnerand those who participated in signing the return;

– 6 year S/L for the “innocent partners” (IF IDENTIFIED)

• False or fraudulent statements

BLIND SPOTS – Not KnowingWith TEFRA, It Ain’t Over ‘Til It’s Over

79


Part VI

Watching for the Blind Spots WhenDrafting Agreements

80


BLIND SPOTSTHE RISK OF OPERATING W/O A WRITTEN AGREEMENT

Articles ofOrganization

Auth. Rep:Mr. CPA

1997

CPA

Columbus Bar Ass’n v. Verne, 788 NE 2d 1064 (Ohio 2003)

LLC Formed by CPA

Bus. Man #1

Bus. Man #2

“You Don’t Need aLawyer When

Making Choice ofEntity Decisions”

“(CPA) drafted articles oforganization, using formsavailable from the Sec. ofState’s office as abaseline, to establish thebusiness as a LLC”

81


Watch Out for Blind Spots

When Drafting Agreements

TAX NON-TAX

82


6.11 Resignation. Any Manager may resign at any time by giving written notice to the Class A Members, and any Officer mayresign at any time by giving written notice to any Manager, and no such resignation need be accepted in order to be effective.

6.12 Delegation of Powers. The Board of Managers may delegate its authority and powers, but not its responsibilities, to theOfficers, to employees or Affiliates of any Member, or to any other Person.

6.13 Authority of the Members. Except as otherwise provided herein, no Member may act for, obligate, or in any manner legallybind, the Company or any other Member, unless such Member has been authorized to do so herein, or has been authorized to do

so, in writing, by the Board of Managers. Any Member acting in contravention of this provision hereby agrees to indemnify,insure and hold harmless the Company and each other Member from and against, and reimburse them for, any and all liability,loss, cost, expense or damage incurred or sustained by reason thereof, including, but not limited to, court costs and reasonable

attorney and paralegal fees and costs through any and all negotiations, trials and appeals and through all settlement andcollection proceedings.

Alternative:6.12 Delegation of Powers. The Manager may delegate its authority and powers, but not itsresponsibilities, to the Officers, to employees or Affiliates of any Member, or to any other Person.

6.13 Standards of Care Owed by Manager. In performing its duties hereunder, the Manager (and anyofficers acting under delegation of such Manager’s authority) shall owe a duty of loyalty and duty ofcare to the Company and all of the Members in the Company, as such duties are defined under theAct. The duty of loyalty includes, without limitation, accounting to the Company and holding as

trustee for the Company any property, profit, or benefit derived by such Manager in the conduct orwinding up of the Company business or derived from a use by such Manager of Company property,including appropriation of a Company opportunity, refraining from dealing with the Company inthe conduct or winding up of the Company business as or on behalf of a party having an interest

adverse to the Company, refraining from competing with the Company in the conduct of Companybusiness before dissolution of the Company. The duty of care is limited to refraining from engagingin grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.The Manager shall discharge its duties under this Agreement and the Act and exercise any rightsconsistent with the obligations of good faith and fair dealing. In discharging a Manager’s duties

hereunder, the Manager is entitled to rely on information, opinions, reports, or statements, includingfinancial statements and other financial data, if prepared or presented by one or more Members oremployees of the Company whom the Manager reasonably believes to be reliable and competent in

the matters presented, legal counsel, public accountants, or other persons as to matters the Managerreasonably believes are within the persons’ professional or expert competence, or a committee ofMembers of which the Manager is not a participant if the Manager reasonably believes that suchcommittee merits confidence. In discharging the Manager’s duties hereunder, the Manager may

consider such factors as the Manager deems relevant, including the long-term prospects andinterests of the Company and its Members, and the social, economic, legal, or other effects of anyaction on the employees, suppliers, customers of the Company, the communities, and society in

which the Company operates, and the economy of the state and the nation; provided, however, that aManager shall not be deemed to have acted in good faith if the Manager has knowledge concerningthe matter in question that makes the above referenced reliance unwarranted. A Manager shall not

be liable for any action taken by a Manager, or any failure to take any action, but only if theManager performed the duties of the Manager’s position in compliance with the Act.

Nonwaivable Provisions –

A limited liability company operatingagreement may not eliminate the duty ofloyalty, unreasonably reduce the duty ofcare, or eliminate the obligation of goodfaith and fair dealing. See F.S. 608.423.

Delaware?

Recent casessuggest that theseduties cannot be

eliminated inDelaware.

83


BLIND SPOTSWHEN DOES LIFE BEGIN FOR YOUR TAX P’SHIP?

Cert ofLtd.P’ship

Filed

9/2/82

MapleVillageP’ship

(purch/oper shop.ctr)

$90

Mr. Robert Johnston

90%GP

Initial Limited Partner

$10

10% LP

Conf. Private PlacementMemorandum

40 Units offered for sale at$200,000/unit (2.475% LPinterest per unit), via N/Pand $11,750 down

GP will make nocapital contribution, butwill own 1% of the capital,profits, and losses of entity

GP will receive aone-time org. feeof $30,000

ExclusiveRight toManage

INVESTORS

$$$(escrow)

ClosingDec.1982

84


A partnership agreement will comply with the 704(b) safeharbors, either the: (1) economic effect test (i.e., with aDRO); or (2) the alternate economic effect test (i.e., witha QIO) and therefore “protect” any allocation:

– “if, and only if,”

– it contains one of these safe harbors

– “throughout the full term of the partnership”

A TAX BLIND SPOT“IF, AND ONLY IF” YOUR ALTERNATE ECONOMIC

EFFECT TEST IS IN PLACE “THROUGHOUT THE FULLTERM OF THE PARTNERSHIP”

THIS PLACES EXTREME IMPORTANCE ON DRAFTING FORTHESE PROVISIONS INITIALLY AS COMMENTATORS WARNTHAT SUBSEQUENT AMENDMENTS/RESTATEMENTS MIGHTNOT DO IT!!!!

85


• ALTERNATE ECONOMIC EFFECT TEST

– SAFE HARBOR UNDER THE 704(B) REGULATIONS• A Special Allocation will have “economic effect” (tax follows

book) if the partnership agreement contains provisions thatrequire:

– (1) determination and maintenance of partners’ capital accounts inaccordance with the rules of Section 1.704-1(b)(2)(iv);

– (2) upon liquidation of the partnership, the proceeds of liquidationbe distributed in accordance with the partners’ positive capitalaccount balances;

– and

– (3) a hypothetical reduction of the partners’ capital accounts, fordistributions that, as of the end of the year, are reasonablyexpected to be made (precludes partners from timing dist’ns)

– and

– (4) a legally sufficient Qualified Income Offset (QIO)

A TAX BLIND SPOTWATCHING OUT FOR A

“LESS-THAN-PERFECT” QIO

USE LOSS LIMITATION RULE86


• “Qualified Income Offset” (QIO)—designed to preclude a partnerfrom timing the receipt of distributions or allocations of deductions soas to accumulate a negative capital account that he will never haveto restore.

• Interhotel Company, Ltd. v. IRS, T.C.Memo 2001-151– Second amendment to partnership agreement provided for a net

income allocation to pay off a deficit capital account, but it fell short ofproviding for a sufficient QIO

• “A partnership agreement contains a legally sufficient QIO only if itprovides that a partner who unexpectedly receives an adjustment,allocation, or distribution described in 1.704-1(b)(2)(ii)(d)(4), (5), or(6) (‘the 4,5,6 rules’) that causes or increases a deficit balance in acapital account, will be allocated items of (gross) income and gain inan amount and manner sufficient to eliminate the deficit balance asquickly as possible.”

ANOTHER TAX BLIND SPOTWATCHING OUT FOR A “LESS-THAN-PERFECT” QIO

87


ANOTHER TAX BLIND SPOTKNOWING HOW RETURNS CAN IMPACT THE PIP TEST

Partners’ Interest in the Partnership Test

(1) Relative Capital Contributions Records insufficient

(2) Sharing of economics Varied each year

(3) Interest in cash flow From each operation

(4) Right to Liquidating Distributions 50/50 (settlement disc.)

(5) Partnership Returns: (1980-1994) 50/50 (never disputed)

Estate of Ballantyne v. IRS, T.C.Memo 2002-160, aff’d, 92 AFTR 2d 2003 (2003)

Melvin Ballantyne Russell Ballantyne

Ran oil & gasoperations

Ran farmingoperations

No P’ship K50 yrs of P’ship TaxReturns ----50/50

88


ANOTHER TAX BLIND SPOTARE YOU “TOO SMART” TO RELY ON THE

“DUMB BUT LUCKY RULE”

• So, Will the “Dumb But Lucky Rule” Always Save You?• Boca Investorings P’ship v. U.S., 91 AFTR 2d 2003-44 (D.C.Cir.

2003)– In 1990, American Home Products sold sub for $605 million CG– Just before the sale, Merrill Lynch approached them with an

investment plan which would enable AHP to claim paper taxlosses of approximately $600 million, while generating onlyabout $8 million in actual losses

• Boca’s Partnership Agreement: (1) “…for the determination andmaintenance of capital accounts”; (2) that liquidating distributionswere to be made in accordance with the partners’ positive capitalaccount balances; and (3) that any partner with deficit balancerequired to restore deficit balance in a timely manner (i.e., a DRO).”

No Ref.to 704

NOTE: NEW PROP. REGS.: EXPANDOPPORTUNITIES FOR REVALUATION—SHOULD INCORPORATE INTO OURAGREEMENTS!

89


TAX BLIND SPOTLEAVING YOUR CLIENT OUT IN THE COLD, WHEN NO

704(C) METHOD IS ADOPTED

• Failing to addresswhat type of 704(c)method to adopt maynot be prudent since:

– Property may havebeen contributed

– Revaluations canoccur at any time

• Who is your client?

90


TAX BLIND SPOTWho is Your TMP?

• Leatherstocking 1983 Partnership v. IRS(10/20/08)

– Extension invalid if TMP suffers fromdisabling conflict of interest

– TMP must be “owner”

91


IPO II, LLC v. IRS, 122 T.C. No. 17 (4/23/2004)Economic Risk of Loss Borne by Related Parties & the Related

Partner Exception

IPO II,LLC

Chart. Aircraft

Indeck Overseas, Inc.

(S Corp)

Mr. Forsythe (TMP)

TEFRA

K-1

K-1

99 Units(99%)

1 Unit (1%)

100%

K-1

Personal

Guarantees

(WaivingAllRights ofSubrogation)

$9.4 Million

P/N

To PurchaseAircraft

BANK

NoGuarantee

($1,385,457)

100% Debt Allocation(Basis)

MANAGER

Indeck Energy

(S Corp)

Indeck PowerEquip. Co.

RECOURSEDEBT

No IncreasedBasis!!!

92


Part VII

Watching for the Blind Spots inOperations

93


BLIND SPOTS IN OPERATIONSFictitious Names

Disclosing Your True Identity

“What’s Your Name?”

“May I See Some Identification?”

“Who Do You Work For?”

94


BLIND SPOTS IN OPERATIONSIs NEWCO really still OLDCO?

C&NLaw Firm

SAME EIN

C

N

F

State law: dissolution (1969)

2 of the 3 partners form new firm

Since a sufficient part of thebusiness continued to be carriedon, then the FC&N firm cannot be

considered to have beenterminated for tax purposes.

Therefore, receipt of a few items byF does not constitute a liquidation

of his interests in the p’ship.

Neubecker v. IRS, 65 T.C. 577 (1975)

Now See708 Merger

Regs.

FC&NLaw Firm

95


BLIND SPOTS IN OPERATIONSDon’t Let the Form of the Transaction Hide a COI Issue

The Clearwater Tower

Huntington Bank

14.5mil.(rec)

MAS ONELTD. P’SHIP

MIDLAND MUTUAL LIFE INS.

MAS ONE GENERALS JV

Mas One Ltd. P’ship v. U.S., 92 AFTR2d 2003-XXXX (S.D.Ohio 2003)

$2.5 mil. Capguarantee, plus

Debt Serv.guaranty of allinterest

LimitedGuarantee

GP

96


BLIND SPOTS IN OPERATIONDon’t Let the Form of the Transaction Hide a COI Issue

The Clearwater Tower

IS SOLD ON 12/29/94Huntington Bank


MIDLAND MUTUAL LIFE INS.MAS ONE GENERALS JV

Mas One Ltd. P’ship v. U.S., 92 AFTR 2d 2003-XXXX (S.D.Ohio2003)(WILL NOT QUALIFY AS A CAPITAL CONTRIBUTION!!)

GP

Proceeds: $4.1 mil

1105 CORP

12/27/941%

Admittedas LP

12/28/94

NOTICE OFABANDONMENT

OF LP INT.

12/29/94(AfterabandoningLP int, paysoff loan at$8.3 million)

INCOME

97



BLIND SPOTS IN OPERATIONSDon’t Let the Form of the Transaction Hide a COI Issue

Huntington Bank

MIDLAND MUTUAL LIFE INS.MAS ONE GENERALS JV

Mas One Ltd. P’ship v. U.S., 92 AFTR 2d 2003-XXXX (S.D.Ohio2003)(WILL NOT QUALIFY AS A CAPITAL CONTRIBUTION!!)

GP

1105 CORP

12/27/941%

Admittedas LP

12/28/94

NOTICE OFABANDONMENT

OF LP INT.

12/29/94(AfterabandoningLP int, paysoff loan at$8.3 million)

CAP

CONT.

Even if it werea capital cont.,then a deemed

distribution to GP

COURT:

WhywouldMidlandpay morethan itowed?Assumed Debt

98


BLIND SPOTS IN OPERATIONSMore on COI Issues

AMERICAN RECOVERY AND REINVESTMENTACT OF 2009

NEWI.R.C. Sec. 108(i)

Applicable Debt InstrumentThe Special 108(i) Election (made by entity, impact

on each partner may be different)What about 708(b)(1)(B) terminations (more than

50% of the interest in capital/profits)?Partial redemptions of partnership interests?

Tiered partnerships?Partnership allocations?

99


Getting Sloppy with the Purported DRE/SPE

• Evaluating HybridFinancing—The TaxIssues

– Equity Kickers(Interest Enhancers):Is lender de factopartner?

• Convertible DebtInstruments

• Options

• Shared AppreciationMortgages

• Irrevocable Lines of Credit

• Demand Notes

TaxPandemonium

If Equity, then….

NEW: Prop.Regs.-Noncomp. Options

with Anti-Abuse Rule!!!!!

Let theReallocationsBegin!!!!!

100


BLIND SPOTS IN OPERATIONSWatch Out for Noncompensatory (and Compensatory)

“Options”

100 Units

CLASS AMEMBER JS

LENDER

LLC

CLASS AMEMBER

$10,000

$10,000

100 Units

LOAN: $10,000

5 YEAR NOTE;INT. OF $1000/YR

Loan Document

JS has the right toconvert debt into100 LLC units (withfull rights to capital,profits, losses)

Prop. Regs. 1.721-2(d) “Noncompensatory Option” means a call option orwarrant, the conversion feature of convertible debt, or the conversion

feature of convertible equity (i.e. preferred equity convertible into common)

101


BLIND SPOTS IN OPERATIONSWatch Out for Noncompensatory (and

Compensatory) “Options”

CLASS AMEMBER

JS

LENDER

CLASS AMEMBER

$30,000

Loan Document

JS has the right toconvert debt into100 LLC units (withfull rights to capital,profits, losses)

Equipment

Dep./15 yrs.

Allocations of Net Income: $2,000/yr for 3 yrs

50%

50%

Capital A/C

10,000 Initial

3,000 Alloc.

13,000 after 3

10,000 Initial

3,000 Alloc.

13,000 after 3

102


BLIND SPOTS IN OPERATIONSWatch Out for Noncompensatory (and

Compensatory) “Options”

CLASS AMEMBER

JS

LENDER

CLASS AMEMBER

$ 12,000

Plus, Equip.

FMV: 30,000

AB: 24,000

In year 4, JS Lender “converts” debt into 100 LLC Units

50%

50%

Capital A/C

10,000 Initial

3,000 Alloc.

13,000 after 3

10,000 Initial

3,000 Alloc.

13,000 after 3

Under Prop. Regs.,Lender’s capital account isequal to the AB of the debtright conversion($10,000), plus anyaccrued, unpaid qualifiedstated interest. Plus,Lender gets the right toreceive LLC capital equalto 1/3, or $15,000 ($45/3)

103


• Focus on beneficial ownership• Medlin v. IRS, T.C.Memo 2003-224 (7/29/03)

– (taxpayer not allowed to claim that property held in aFlorida land trust was really a partnership for federaltax purposes; relationship never rose above merecoownership)

• Are there two or more beneficial interestholders?– If so, by default, it could be taxed as a partnership– If not, could be treated as a disregarded entity (i.e.,

only one beneficial owner)

BLIND SPOTS IN OPERATIONSHow to Classify a Land Trust for Federal Tax

Purposes?

104


BLIND SPOTS IN OPERATIONSDEVELOPER BY ATTRIBUTION PROBLEMS

H-H Ranch, Inc. v. IRS, 357 F.2d 885 (7th Cir. 1966)(courtrejects taxpayers argument that each entity s/b treatedseparately)

Blackhawk Builders, Inc.

Building & selling houses to the publicsince 1941

H-H Ranch, Inc.

Heise Brothers Realty, Inc.

Elgin Farm

C/S

22 acresof Farm

Subdivides into 77 lots

moreacres

Agreement

Any UnsoldLots

Will be Re-conveyed

AGENCY!!!!

105


BLIND SPOTS IN OPERATIONSHOW INVESTMENT COMPANIES MAY BLOW A 1031

UNDER THE “HELD FOR SALE” STANDARD

NEAL T. BAKER ENTERPRISES, INC. v.IRS, T.C.Memo 1998-302

Operator of fast-food restaurants was found to haveheld 48 lots “primarily for sale” and therefore, did notqualify for 103 treatment on sale.

NOTE:

Taxpayerargued thatits originalintent(acquireproperty tosubdivide)had shiftedto one ofinvestment

Company’s Books:Classified

Lots as W-in-P

must manifestchange clearly

106


707(b)(1)(A) – No loss if:

BLIND SPOTS IN OPERATIONSWatching Out for Related Party Transactions

P’ship

Sale/ExchangeTP

If TP owns, directly/indirectly,greater than 50% of profitsOR capital

P’ship P’ship

707(b)(1)(B) – No loss if:

Sale/Exchange

LOSS LIMITATION—RELATEDPARTY RULES

267(c) att.rules

107


707(b)(2)(A) – Any gain will be ORDINARY if:


P’ship

Sale/ExchangeTP


P’ship P’ship

707(b)(2)(B) – Any gainwill be ORDINARY if:

Sale/Exchange

CG DISALLOWANCE—RELATED PARTY RULES

267(c) att.rules

108


• Section 1239 – Any gain will be ORDINARY if:

P’ship

Sale orexchange ofdepreciablepropertyTP


– OR –

any “controlledentity”


Any “related person asDefined under 1239(b)

109


Part VIII

Watching for the Blind Spots in TaxReturns and Disclosure Issues

110


Part IXWatching for the Blind Spots When Taxand State Law Go in Different Directions

111


ASYMMETRICAL TRANSACTIONS

LLCSTATE

LAW

S CORPFED TAX

LAW

LLC

S CORPELECTION IRS FORM 1120S

112


Part X

Watching for the Blind Spots inConvertibility, Entity Transitions,

Mergers and Divisions

113


Convertibility

• Many states now have very broad entityconversion features for corporations, LLCs,LLPs, etc.

• State law merger statutes not binding onFederal tax law

• Easy to go from LLC to S or C corporation,but much more difficult to go from a C to a Scorporation

• Converting Corp to LLC results in liquidationof Corp.

114


BLIND SPOTSWHEN PURCHASING AN INTEREST FROM THE

OWNER OF A SINGLE-MEMBER LLC

• Rev. Ruling 99-6

LLC

State LawContinuing Entity

100%

Lawyer

“for the deal” SellingMembers

PurchasingMember

AssymmetricalTransactions

Tax Law – 708Termination

115


TAX BLIND SPOTWHEN PURCHASING AN INTEREST FROM THE

OWNER OF A SINGLE-MEMBER LLC

• Rev. Ruling 99-5

Single-MemberLLC

State Law

Continuing Member

100%

-75%

25%

75%

Lawyer

“for the deal” ContinuingMember

PurchasingMember

AssymmetricalTransactions

116


BLIND SPOTSIs NEWCO really still OLDCO?

C&NLaw Firm

SAME EIN

C

N

F

State law: dissolution (1969)

2 of the 3 partners form new firm

Since a sufficient part of thebusiness continued to be carriedon, then the FC&N firm cannot beconsidered to have beenterminated for tax purposes.Therefore, receipt of a few items byF does not constitute a liquidationof his interests in the p’ship.

Neubecker v. IRS, 65 T.C. 577 (1975)

Now See708 Merger

Regs.

FC&NLaw Firm

117


BLIND SPOTSInternational Planning

Partnership

U.S. Partners Foreign Partners

The PartnershipAgreement

The AgreementCap. AccountsSection 704(c)P’ship elections

Etc.

118


Part XI

Some Ethical Considerations inDealing with the Blind Spots

119


Unprotected Business Matters vs. Protected Legal Adviceby Corporate Counsel

U.S. v. KPMG, 92 AFTR 2d 2003-6498 (D.D.C. 2003)

• CRITICAL CONCEPTS MATRIX

• “Legal Advice” by “Legal Counsel” on a “Legal Matter”– Legal Opinion (assuming law firm is engaged by co and not KPMG)– Individualized and Specific to Client

– “Tax Advice” -------------------------------- BUT NOT:– (-----IN SPECIFIC CLIENT FILE------)

– Tax Shelter Opinions & Tax Return Preparation• ------------------------------------------ “Business Matters” & “Informational Purposes”• ------------------------------------------ “Business Strategy Decisions”• ------------------------------------------ “Marketing of Shelters” (by lawyers or CPAs)• ------------------------------------------ Template Opinions & Engagement Letters• (---------IN THE FIRM’S GENERAL FILE-----)

Reproduced from “Problems and Pitfalls in Electronic Discovery for Corporate Counsel” (March 10, 2004)

120


Who is Your Client?

Partnership

National Tax Credit Partners, L.P. v.Manhatten, Ltd., 1992 U.S.Dist. LEXIS 1644

ClosingAttorney

M.R. 1.13Organization

as a Client

121


What Hat Are You Wearing?

“Business Advisor”

“Lawyer”

Tax Advisor

122


BLIND SPOTWhen the Preliminary Discussions with theCPA Bite You and Your Client (G-I Holdings)

• 1990:

• Preliminary DiscussionsHeld to Conduct Sale of 2Subsidiaries by GAFCorp. to Rhone-PoulencSurfactants & Specialties,Ltd.

• Tax Advisors:– McKee Nelson

– Arthur Andersen

McKee, Nelson Under Siege

123


BLIND SPOTWhen the Preliminary Discussions with the

CPA Bite You and Your Client

GAF CHEMICALSCORP.



Specialties, LP

RHONE-POULENC


GP

LP

$26 MillionEquity Stake1990 “721”


Given the right to retire 98% ofGAF’s p’ship interest, but only afterexpiration of 3-year TAXDISGUISED SALE RULE PERIOD

McKee, NelsonIssues tax opinion

letterThis “should” work!!

124




GAF CHEMICALSCORP.



Specialties, LP

RHONE-POULENC


GP

LP


IRS: PROOF OF CLAIMS FOR

G-I HOLDINGS: $400 MILLION$400 MILLION

ACI: $530 MILLION$530 MILLION, PLUSPENALTIES OF $49 MILLION$49 MILLION

File forBankruptcy

IRS: 1990 TRANSACTION WAS A TAXABLE DISGUISEDSALE OF PROPERTY BY GAF TO EITHER THE LP, ORTHE GP UNDER 707(a). ALTERNATIVELY, LP WAS NOTA VALID P’SHIP, OR IF IT WAS, GAF WERE NOT VALIDPARTNERS FOR TAX PURPOSES.

125




GAF CHEMICALSCORP.



Specialties, LP

LP


IRS LITIGATION STRATEGY

ISSUES FPAA TO P’SHIP/TMP RIGHTBEFORE EXPIRATION OF TEFRA 6YEAR S/L(6229(c))(i.e., Sept. 1997) fora 1990 Transaction)

In re G-I Holdings, Inc., (D.NJ. 7/17/03)

--Debtors have waived their attorney-clientprivilege with regard to SM of the 1990transaction and subsequent events. Mustproduce all relevant communications with ArthurAndersen and McKee & Nelson.

Response toInterrogatory

Claiming reasonablereliance defense to

Assertions of penalties

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BLIND SPOTUPDATE ON G-I HOLDINGS (2009)

• Post-Trial Briefings:•Government’s View of Case:

•P’ship was a “sham”•GAF is not a “partner”•De Facto Sale of at least $450million by GAF•Section 707(a)(2)(B) Applies(Disguised Sale Rules)•GAF did, in fact, omit 25% of“gross income” to permit 6-year S/L to apply•GAF is liable for penalties

127


BLIND SPOTUPDATE ON G-I HOLDINGS (2009)

• Post-Trial Briefings:•Debtor’s View of Case:

•GAF is a “partner”•Can’t bifurcate GAF’s interest•If Gov’t succeeds inbifurcation approach, tax worldand capital markets go upsidedown•GAF did not omit 25% of“gross income”•GAF is not liable for penalties

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Summary and Review


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Date post:	25-Jun-2015
Category:	Business
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