Watching Out For the Blind Spots of Partnership Tax Vehicles

Watching Out For the Blind Spots of
Partnership Tax Vehicles

September 23, 2009
© 2009 T. Scott Tufts, Esq.

Watching Out For the Blind Spots of
Partnership Tax Vehicles

INTRODUCTION
© 2009 T. Scott Tufts, Esq.
2

The Pass-Through Entities
Your vehicle of choice?
Joint Venture Limited P’ship
General P’ship (Ltd.)

LLP LLLP
Single-Member LLC
Member-Managed Manager-Managed
LLC LLC

S Corporation????

© 2009 T. Scott Tufts, Esq. 3

Full Speed Ahead……

LLC LLP

LLLP

…and don’t look back?

Partnerships at Formation…..
Partner Partner
Member #1 Member #2

Limited Liability Entity


….can end up in the courtroom

What “Promises” Were Made?
What “Promises” Were Broken?
Who Gets What?


….and you might find yourself right
in the middle!!!!


Whistleblowers & SAR/OX


Divorce Disclosures

Financial
Disclosure
Statement
IRS FORM 8857

Innocent
Spouse
Protections


Policing the Highways


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

Credit Card Summons
IRS Form 8886 (Tax
Shelters & More)
Foreign Bank A/C
(Sch. B, F.1040)
Informant Rewards
(Form 211 & K w/ US)
No More Secrecy
Offshore

IRS Form 8082 (K-1
Taxpayer & Matching Program)
his/her law firm

........WHEN THE GOVERNMENT IS IN SEARCH OF
REVENUES?

IRS Knows IRS
That Complex Issuing IDRs
P’ship Structures to
Often Times Tax Shelter
Is a Tax Shelter Participants!


THE NEW & IMPROVED
IRS’ K-1 MATCHING PROGRAM
Man. GP GP Manager

K-1
K-1

LLP LLLP LLC

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

Partner Limited Member Member
Partners
Partner


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 practitioner
privilege)
• 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)

Part I
Overview of the LLP,
LLC and LLLP Entity

(and Other Entity Options)

The Choice Of Entity Menu
• Corporation • General Partnership (RUPA)
– “C” Corporation – Regular
– “S” Corporation – Joint Venture
• Limited Liability Company – New: LLP
(LLC) • Local Trusts (Spendthrift)
– Member-managed • Business Trust (Delaware)
– Manager-managed • Florida Land Trust
– Single-Member/Tax Nothing
• REITs (QRS; TRS; PSS)
– Multiple-Member
• REMIC; FASIT; TMP
– Bankruptcy Remote
– FLLCs • Domestic Protection Trusts
• Sole Proprietorship (Delaware, Alaska, Nevada, Rhode
Island, etc.)
• Branch/Division
• Foreign Trusts (Offshore)
• Limited Partnership
– The “Affordable Media” Problem &
(RULPA)(Ltd.)
the Offshore Credit Cards
– w/Corp. GP?
– New: “LLLP” (GP-Safe?) – Schedule B/Disclosure Issues
– FLPs

Statutory Adoption of LLC
Corporate Piercing of the Veil
Standard
• F.S. Sec. 608.701: “In any case in which a party seeks to hold the
members of a LLC personally liable for the liabilities or alleged
improper actions of the LLC, the court shall apply the case law
which interprets the conditions and circumstances under which the
corporate veil of a corporation may be pierced under the law of this
state.”
– Dania Jai-Alai Palace, Inc. v. Sykes, 450 So.2d 1114 (Fla.
1984)(no veil piercing unless LLC was organized or used to mislead
creditors 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….., and
undercapitalization is an indicator of “bad motive”


LLP
Something New To Think About…

The Florida Limited Liability Partnership
(F.S. Sec. 620.9001 et.seq.)
“An obligation of a partnership while the partnership
is a LLP, whether arising in contract, tort, or
otherwise, is solely the obligation of the partnership.
A partner is not personally liable, directly or
indirectly, by way of contribution or otherwise, for
such an obligation solely by reason of being or so
acting as a partner.” F.S. Sec. 620.8306(3)


LLLP
And, ……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 of
Qualification; and (3) complying with the name
requirements.”
Section 620.8306(3) of RUPA shall apply to both
general and limited partners of a LLLP such that “an
obligation of a partnership while the partnership is a
LLLP, 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 or
otherwise, for such an obligation solely by reason of
being or so acting as a partner” in a LLLP.

S Corporation
• 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.


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

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


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

2 Basic Types
Corp-Like P’ship-Like

Corp-like Shield Member-Managed General P’ship
LLC
Model

Ltd. P’ship
Corp-like Shield Manager-Managed
LLC Model


Sole Proprietorship
(Schedule C)


Single-Member LLCs
SINGLE-MEMBER Member: 100%
LLC

BANKRUPTCY REMOTE
LLC
Member:100%
(Tax Purposes)

Tax Nothings, but “Real” Entities Under State Law


SINGLE MEMBER
LLC

Creditors
?

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

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

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


……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 of
Corp, followed by recontribution
of assets to LLC
• Multistate Tax Issues
– Woops! Tenn/Texas tax LLCs
like Corps. (as Fla used to do)
– Woops! Some States do not
recognize fully-shielded LLPs or
Single-Member LLCs


……but not the “Wrong” Choice
• Family Estate Planning
– No “discounts” for FLLP; But
FLP/FLLC?
– 2036 (Eff. Control) Problem
– A Business Purpose? A Gift?
• S Corp. Shareholder Problem
– Inadvertent Termination (Ineligible
Shareholders (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 to
SECA/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?

Getting Sloppy with the Purported DRE/SPE

• Evaluating Hybrid
Financing—The Tax If Equity, then….
Issues Tax
Pandemonium
– Equity Kickers
(Interest Enhancers):
Is lender de facto
partner?
• Convertible Debt Let the
Instruments
Reallocations
• Options Begin!!!!!
• Shared Appreciation
Mortgages
• Irrevocable Lines of Credit
• Demand Notes NEW: Prop.Regs.-Noncomp. Options
with Anti-Abuse Rule!!!!!

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


Part II
Understanding the Partnership Tax
Vehicle

Not Quite What You Might
Think

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 one
member) or have entity disregarded (if only one member);
otherwise, classified as corporation (unless all members don’t
have limited liability)


A TEFRA Blind Spot
for an Actually Blind Taxpayer
Can this be
Fair?

TEFRA

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


Part III
Watching for the Blind Spots
in Entity Selection


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


BLIND SPOTS IN ENTITY SELECTION
When 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 is
made that entity will be a member-managed LLC, unless
otherwise provided in its articles of organization or
operating agreement and in a member-managed LLC, each
member is an agent of the LLC

Part IV
Watching for the Blind Spots
in Entity Formation


BLIND SPOTS IN FORMATION
THE RISK OF OPERATING W/O A WRITTEN AGREEMENT
“You Don’t Need a
Lawyer When
CPA Making Choice of
Entity Decisions”

Articles of “(CPA) drafted articles of
Organization organization, using forms
Auth. available from the Sec. of
Rep.: State’s office as a
Bus. Man #1 baseline, to establish the
Mr. CPA business as a LLC”
Bus. Man #2
1997

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


THE RISK OF OPERATING W/O A WRITTEN AGREEMENT (con’t)

Lawyer
then files a
UPL
grievance
with
Angry partner goes to lawyer, who Columbus
reviews documents and discovers that Bar Ass’n
“Partners” have a falling out no operating agreement had been
executed.

Sup.Ct. of Ohio: “…an omission that commentators caution
1999-2000
against” ……”.‘written operating agreements minimize disputes,
prevent fraud, protect the legitimate expectations of the members,
and avoid or minimize problems with disregard of the entity for
liability purposes.’” citing to H&M, Ohio LLC Forms and Practice
Manual (Dec. 2001).

THE RISK OF OPERATING W/O A WRITTEN AGREEMENT (con’t)

CPA’S LAWYER TO THE JUDGE:
“ISN’T THE FILING OF ARTICLES OF
ORGANIZATION MERELY A CLERICAL
SERVICE?????”

CPA’s Lawyer Argues: Court: No. “For a layperson to draft documents
creating a business entity on another’s behalf is
“As a CPA, he is
capable of competently
unquestionably the unauthorized practice of law.” citing,
advising clients in the Florida Bar v. Mills, 398 So.2d 1368 (Fla. 1981)”
creation of these
documents.”
Mills: Florida Supreme Court: “drafting of articles of
incorporation is the practice of law.” citing to Fuentes,
Keehley, Town


BLIND SPOTS IN FORMATION (cont’d)
The Result in Verne: UPL Violation

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


THE RISKS OF OPERATING W/O A WRITTEN AGREEMENT

– What About Florida?
– Commentators:
• “Organizers of LLCs should not delay the execution of the
operating agreement beyond the consummation of any
transactions involving the LLC, including acceptance of
capital contributions to the LLC, since the operating
agreement generally will be necessary to establish the
relative rights, authority, powers and duties of the
manager(s) or managing members and of the members
inter se, matters which typically are not covered in the
articles of organization.” Cohn & Ames, Fla.Bus.Laws
Ann., 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 OF
ARTICLES, WHICH “TAKES EFFECT” UPON THE FILING OF THE ARTICLES

Blind Spots in Formation
The Failure to Properly Advise with Respect to
Capital Contributions!!
“But, Your
Honor….,
the CPA told me
that I could simply
leave the
“Schedule A”
blank!

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

Service 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 Into
Cash


Overlooking the Importance of Capitalization and the
Prefunding Process:
How To Do It?
Estate of Stone
Start of Negotiations Capital Start of Business
Contribution.
P’ship
Agreement
Agreement
Rev.
Rev.
Draft
Draft

P’ship
Agreement
FLP/FLLC
Draft

Family and Lots of Lawyers

Overlooking the Importance of Capitalization and the
Prefunding Process:
How Not To Do It?
P’ship
Estate of Hillgren
Agreement
Start of Business Untimely
Death Effective
1/1/1997 “as of”
No Written Oper. Agreement
1/1/1997
No Negotiations
Lawyer for the Deal

FLP/FLLC
Mr.Hillgren Ms.Hillgren/
© 2009 T. Scott Tufts, Esq. Estate 47

Overlooking the Importance of Capitalization –
Family Estate Planning
How Not To Do It?
Heckerman v. IRS (W.D.Wash. 2009)

FAMILY
LLC

CHILD TRUST-1

“SAME DAY” CHILD TRUST-2



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 (and
therefore, no utilization of your unified credit). At that time, effectively
you 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 gift
ownership in the LLC to the kids or their trusts. For example, say you
put $4,000,000 into the LLC. Immediately after, you own 100% of the
LLC. 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 we
are using the LLC (and the resultant discounts), even though the
combined 50% of the assets is $2,000,000, for gift taxes the IRS only
considers 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 get
the remaining ownership of the LLC to your kids or their trusts, you
will make gifts of LLC ownership equal to $20,000 (again grossed up
for the discounts) to each child every year.“ (emphasis added)


Working with Single-Member LLCs

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

SEC

Single
Member
LLC
SON’S TRUST

GC’S TRUST
Transfers to be
Valued as Transfers
of Interests
(Discounts
Apply)!!!!

CAPITAL ACCOUNT MAINTENANCE RULES
& WORKING WITH “AGREED VALUE” CONCEPTS

PROPERTY OWNING
TRUST DEVELOPER

50% + Pref. Ret.
on sales, at agreed 50%
value
Capital Contribution SERVICES
REAL ESTATE ISSUE: IS THE
AB Agreed Value LAND IRS BOUND BY
DEV. LLC WHAT THE
Rural. R/E * *
PARTIES LIST
Beach R/E * * AS “AGREED
Total $1.7 mil $1.2 mil.
1.2 VALUE”?

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


PROPERTY OWNING
TRUST DEVELOPER

REGS. 1.704-1(b)(2)(iv)(h)
Capital Contribution
“For purposes of the C/A maintenance rules
REAL ESTATE under 704(b), the fair market value assigned to
LAND
property contributed to a p’ship…will be
1. “reasonably agreed to”? DEV. LLC correct, provided that: (1) such
regarded as
2. arm’s-length negotiations? value is reasonably agreed to among the
partners in arm’s-length negotiations, and (2) the
3. sufficiently adverse partners have sufficiently adverse interests. If
interests? ..not, …and the value assigned to such property
is overstated or understated (by more than an
4. overstated/understated by insignificant amount), the capital accounts of the
more than an insignificant partners will not be considered to have been
amount? determined and maintained in accordance with”
704(b).



Enron-affiliate
HOUSTON PIPE LINE CO. ENRON CORP.
99.89% LP
cash
Leaseback .01% GP
$1 .1%
for 18 years
mil
LP
Capital Contribution
Bammel Assets
Bammel
AB Agreed Value HPL
Assets
ASSET
Total $30 mil $930 mil.
930
HOLDINGS, Ltd.
(Del. LP)

Elects: Remedial Method
(704(c))


Tax
Strategy: OSPREY INVESTORS
Distribute ENRON CORP.
Bammel
.1%
Assets back
to HPL after
Whitewing
SM LP
16 years, in LP LLC
redem. of
its LP 99.89% LP .01% GP
Pref. HOUSTON PIPE LINE CO.
LP SM
LLC
Bammel HPL
Recover ASSET
Assets
dep. Using HOLDINGS, Ltd.
150% dec., (Del. LP)
over 15 yrs Allocate 100%
of Deprec. Elects: Remedial Method
to Enron (704(c))

Testing “Agreed Values” THESE PARTIES ARE AFFILIATED…….
Capital Contributions
of Property HOUSTON PIPE LINE CO. ENRON CORP.
1. “reasonably agreed to”?
Bammel
2. arm’s-length Capital Contribution Assets $1
negotiations? Bammel Assets mil .1%
3. sufficiently adverse AB Agreed Value LP
HPL
interests?
Total $30 mil $930 mil.
930 ASSET
4. overstated or HOLDINGS, Ltd.
understated by more (Del. LP)
than an insignificant
amount?
JCT Enron Rep’t: (2003) “…Enron did not obtain an appraisal of the Bammel
Assets…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 clear
whether the value …declined by 50% or whether the original valuation …was
grossly overstated to maximize the tax benefits of” this project.”

BLIND SPOTS AT FORMATION
WHEN DOES LIFE BEGIN FOR YOUR TAX P’SHIP?
Mr. Robert Johnston Initial Limited Partner
$90 $10
Cert of 90% 10% LP INVESTORS
Ltd. GP Maple
P’ship
Village Conf. Private Placement $$$
P’ship Memorandum (escrow)
Filed (purch/oper shop. ctr)
40 Units offered for sale at
9/2/82
$200,000/unit (2.475% LP
interest per unit), via N/P
and $11,750 down
GP will make no
Exclusive capital contribution, but Closing
GP will receive a
Right to will own 1% of the capital, Dec.
one-time org. fee
Manage profits, and losses of entity 1982
of $30,000


Capital: IRS: Cap. Shift—FMV $80,808
$470K Bank
Dec. 31, 1982
$7.5 million $12 million
N/P Partner CapCont %
$600,000 down
Maple mtg. $11.4 GP $ 90, +serv. 1.0
Village
LP Inv. $8 million 99.0
Ltd. P’ship Man. Fee ($)

Leased to: Orig. Corp.
Sponsor P’ship Begins for Tax Purposes
Closing
Dec. Eccelston Prop., Ltd.
1982 Purchase of Shopping
Center Location Johnston v. IRS, T.C.Memo 1995-166 (finding
capital shift and assessing neg. penalties)


WHEN OSTENSIBLE SELLERS WANT TO BECOME
PARTNERS WITH THEIR BUYERS
McKee, Nelson
ALKARIL CHEMICALS,
issues tax opinion
Inc.
GAF CHEMICALS letter.
CORP. This “should” work!!
$26 Million
(G-I Holdings, Inc.) Equity Stake
1990 “721”
LP
Rhone-Poulenc
Surfactants &
GP Specialties, LP
RHONE-POULENC
Given the right to retire 98% of
SURFACTANTS & GAF’s p’ship interest, but only after
SPECIALTIES, INC. expiration of 3-year TAX
DISGUISED SALE RULE PERIOD


WHEN T-IN-C OWNERS ARE “TAX” PARTNERS

• Rev. Proc. 2002-22 (procedures for obtaining IRS ruling that undivided
fractional interest in R/E is not a p’ship)
– Co-owners’ activities must be limited to those customarily
performed 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 conserve
property—can be classified as a p’ship!! Cf. Rev.Rul. 79-77 (trust-ok)


WHEN T-IN-C OWNERS ARE “TAX” PARTNERS
Title to R/E Taken As
Tenants-in-Common

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

Assume: No Representations
of State Law P’ship Tax Returns (Form 1065) Filed?

Representations
Filing of
of JV/P’ship
Tax Return
In F/S May “Estop”
..... Don’t Worry, Be Happy???? May “Estop”
Taxpayer!
Taxpayer!!


OIL AND GAS & THE SECA TAX FOR GRANNY

• Court: “We find that, because
(Ethyle) was obligated under
(oil & gas agreement) to
manage and operate her own
interests, she was engaged in
the business of producing and
selling gas…Whether (Ethyle)
was personally involved in
operating the business or used
the services of an agent or Ethyle, 92:
employee to achieve that end “I’m too old, merely passive owner.
makes no difference; the net Not self-employed.”
income realized therefrom
retains its character as self- Ethyle Moorhead v. IRS,
T.C.Memo 1993-314
employment income.”


Farm Rents & the SECA Tax
Rents Not Tied Rents Tied to
to Production Production

Johnson v. Comm’r, Solvie v. Comm’r,
T.C.Memo 2004-56 T.C.Memo 2004-55


Agreements to Purchase, Renovate & Sell R/E:
A “Tax” Joint Venture in Disguise?
50/50
---Practicing full-time Profits

DOCTOR
R/E Operator
$$$

To purchase, renovate residential R/E
Passive?? Provide actual management of project
R/E Sales
• 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)


Blind Spots in Formation:
Alliances
Auditor Independence


Accommodation Parties

Tax-Neutral Tax-Motivated


Accommodation Parties in Action?
Tax Efficiency or Abusive Tax Planning?

BILLIONAIRE
BANKER BEAL
CINDA’S USA
LLC SUB


SOUTHGATE MASTER FUND, LLC
(N.D. TEX 2009)
$1.1 BILLION NON
PERFORMING
LOANS IN
CHINA
$100,000 1%
CINDA’S USA
SOUTHGATE SUB LLC
TMP MASTER FUND, LLC
99%
MARTEL
ASSOCIATES, LLC
19000 Obligors Spread
Out All Over China
SHIFTING $1.1` 24,000 Distressed Asset Loans
BILLION BUILT-IN
BILLIONAIRE LOSS FMV: $19.4 MILLION?
BANKER BEAL

NEW CASE LAW DEVELOPMENT

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

– Partnership vehicles used by sophisticated banker to purchase
Chinese NPLs, that court found were NOT worthless
– Partnership vehicle used to accomplish Southgate transaction
was a genuine busIness deal, generating $216 million in
losses, but……………
– Another partnership tax vehicle arose that was nothing more
than 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, as
partnership tax vehicle was a sham
– No penalties applied, because legal advice given by qualified
CPAs and tax attorneys and good faith efforts were made to
comply with black-letter law, with due diligence


NEW 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 apply
retroactively, in contingent liability cases
– Plausible for transaction at issue to have economic substance
because of Sala, 552 F.Supp.2d 1167, 1199 (Col. 2008)
– Sala holds for proposition that a Treasury Regulation that
conflicts with underlying statute is invalid, even if cast as an
anti-abuse regulation
– Could taxpayers reasonably rely on Helmer line of cases to find
that options are excluded from calculation of a partner’s basis
in 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)


“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 Liability
Company?
• 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 its
articles and naming Marks named as initial manager; because
Marks was not dispossessed of the belief that he could “bind” the
entity, LLC bound by transaction he entered into as the manager,
despite efforts to remove him).


Part V
The Blind Spots of Not Knowing
What the IRS Is Looking For


The Blind Spots of Not Knowing
What the IRS Is Looking For

Tax The
Shelters MSSP

Tax
Returns


BLIND SPOTS – Not Knowing
Watching Out for Audits Triggered by K-1 Matching Re:
Allocations of Debt
• IRS Exam Techniques—Misallocations of
Basis—Negative Capital Accounts
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)


Watching 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 was
entitled to greater amount of partnership
losses than allowed by IRS.

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

TAX COURT: SCHEDULES K-1 ALONE
ARE NOT SUFFICIENT TO ESTABLISH
SHARE OF LIABILITIES.

CONSIDER WHETHER BURDEN OF
PROOF CHANGES UNDER SECTION
7491 MAY BE OF ASSISTANCE NOW

IRS in Search of Big Wins


Market Segment Specialization Program

MSSP
Guide
Practitioners

Agents /
Examiners


Is your Partnership a “Zombie Partnership”?

• IRS Examination Technique
– “Sometimes a partnership will attempt to avoid TUFTS gain on
disposition of property by sale or foreclosure by claiming that the
liability…still exists. Without relief of liability, no gain is required
to be recognized.
– Partnerships which are no longer actively engaged in
business but which still wander aimlessly about shedding
tax benefits or postponing gain are called “ZOMBIE
PARTNERSHIPS.”
– Look for Partnerships/LLCs with:
• Debt
• Large Negative Capital Account
• Few assets/little activity (or negative assets and no debts)


Is Your Client an “Unidentified Partner” Needing
Protection Under TEFRA?
Unidentified Partner? TEFRA Unidentified Partners?

Beneficiary Mary Doe Bill Roe
K-1
K-1 K-1
John Doe
Family Trust
Pass-Thru F.8082?
LLC

K-1 Source K-1
F.8082?
P’ship


With TEFRA, It Ain’t Over ‘Til It’s Over

• 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 partnership
respected as such for purposes of TEFRA
– “Partner” (TMP) signing FALSE tax returns, even though he
knew that false losses would only benefit other partners
– Special Section 6229(c) statute applies: NO SOL for partner
and those who participated in signing the return;
– 6 year S/L for the “innocent partners” (IF IDENTIFIED)
• False or fraudulent statements

Part VI
Watching for the Blind Spots When
Drafting Agreements


BLIND SPOTS
“You Don’t Need a
Lawyer When
CPA Making Choice of
Entity Decisions”

Articles of “(CPA) drafted articles of
Organization organization, using forms
Auth. Rep: available from the Sec. of
Mr. CPA State’s office as a
Bus. Man #1 baseline, to establish the
1997 business as a LLC”
Bus. Man #2

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


Watch Out for Blind Spots
When Drafting Agreements

TAX NON-TAX


Alternative:
6.11 Resignation. Any Manager may resign at any time by giving written notice to the Class A Members, and any Officer may
resign at any time by giving written noticeThe Manager may no such resignation need be accepted in order to be effective.
6.12 Delegation of Powers. to any Manager, and delegate its authority and powers, but not its
6.12 Delegation of Powers. to the Officers, to employees or Affiliates of and Member, not its responsibilities, to the
responsibilities, The Board of Managers may delegate its authority any powers, butor to any other Person.
6.13 Standards of Care Owed by Manager. In performing its dutiesany other Person. Manager (and any
Officers, to employees or Affiliates of any Member, or to hereunder, the
6.13 Authority of the Members. Except as otherwise provided herein, no Membershall act for, duty of loyalty and duty of
officers acting under delegation of such Manager’s authority) may owe a obligate, or in any manner legally
bind, the Company or any other Member, unless such Member in the Company, as such duties are defined under the do
care to the Company and all of the Members has been authorized to do so herein, or has been authorized to
so, in writing, by the duty of loyalty includes, without limitation, accounting to the Company agrees to indemnify,
Act. The Board of Managers. Any Member acting in contravention of this provision hereby and holding as
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 the Company anysustained byprofit, thereof, including, but not limited to, courtin theand reasonable
trustee for damage incurred or property, reason or benefit derived by such Manager costs conduct or
winding up of the Company business or derived from a use by such Manager of Company property,
attorney and paralegal fees and costs through any and all negotiations, trials and appeals and through all settlement and
including appropriation of a Company opportunity, refraining from dealing with the Company in
collection proceedings.
the 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 Company
business before dissolution of the Company. The duty of care is limited to refraining from engaging
in 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 rights
consistent 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, including
financial statements and other financial data, if prepared or presented by one or more Members or
employees 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 Manager
reasonably believes are within the persons’ professional or expert competence, or a committee of
Delaware?
Members of which the Manager is not a participant if the Manager reasonably believes that such
committee merits confidence. Provisions –Manager’s duties hereunder, the Manager may
Nonwaivable In discharging the
consider such factors as the Manager deems relevant, including the long-term prospects and
Recent cases
A limited liability company operating economic, legal, or other effects of any
interests of the Company and its Members, and the social,
may not eliminate the duty of suggest that society communities, and these
agreement employees, suppliers, customers of the Company, the duties cannot bein a
action on the
which the Company operates, and the economy of the state and the nation; provided, however, that
loyalty, shall not be deemed to have acted in goodduty of Managereliminatedconcerning
Manager unreasonably reduce the faith if the has knowledge
care, liable for any action taken by a Manager, or any failure to take any action, but onlyinthe
the matter in question that the obligation of good unwarranted. A Manager shall not
be
or eliminate makes the above referenced reliance
Delaware. if
faith and fair dealing. See the Manager’s position in compliance with the Act.
Manager performed the duties of F.S. 608.423.


BLIND SPOTS
Mr. Robert Johnston Initial Limited Partner
$90 $10
10% LP INVESTORS
Cert of 90%
Ltd.P’ship Maple $$$
GP
Village Conf. Private Placement (escrow)
P’ship Memorandum
Filed (purch/oper shop.ctr)
40 Units offered for sale at
9/2/82
$200,000/unit (2.475% LP
interest per unit), via N/P
and $11,750 down
GP will make no
Exclusive capital contribution, but Closing
GP will receive a
Right to will own 1% of the capital, Dec.
one-time org. fee
Manage profits, and losses of entity 1982
of $30,000


A TAX BLIND SPOT
“IF, AND ONLY IF” YOUR ALTERNATE ECONOMIC
EFFECT TEST IS IN PLACE “THROUGHOUT THE FULL
TERM OF THE PARTNERSHIP”

A partnership agreement will comply with the 704(b) safe
harbors, either the: (1) economic effect test (i.e., with a
DRO); or (2) the alternate economic effect test (i.e., with
a QIO) and therefore “protect” any allocation:
– “if, and only if,”
– it contains one of these safe harbors
– “throughout the full term of the partnership”

THIS PLACES EXTREME IMPORTANCE ON DRAFTING FOR
THESE PROVISIONS INITIALLY AS COMMENTATORS WARN
THAT SUBSEQUENT AMENDMENTS/RESTATEMENTS MIGHT
NOT DO IT!!!!

A TAX BLIND SPOT
WATCHING OUT FOR A
“LESS-THAN-PERFECT” QIO
• 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 that
require:
– (1) determination and maintenance of partners’ capital accounts in
accordance with the rules of Section 1.704-1(b)(2)(iv);
– (2) upon liquidation of the partnership, the proceeds of liquidation
be distributed in accordance with the partners’ positive capital
account balances;
– and
– (3) a hypothetical reduction of the partners’ capital accounts, for
distributions that, as of the end of the year, are reasonably
expected to be made (precludes partners from timing dist’ns)
– and
– (4) a legally sufficient Qualified Income Offset (QIO)

USE LOSS LIMITATION RULE

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

• “Qualified Income Offset” (QIO)—designed to preclude a partner
from timing the receipt of distributions or allocations of deductions so
as to accumulate a negative capital account that he will never have
to 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 of
providing for a sufficient QIO

• “A partnership agreement contains a legally sufficient QIO only if it
provides 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 a
capital account, will be allocated items of (gross) income and gain in
an amount and manner sufficient to eliminate the deficit balance as
quickly as possible.”


KNOWING HOW RETURNS CAN IMPACT THE PIP TEST

Melvin Ballantyne Russell Ballantyne
Ran farming
Ran oil & gas
operations
operations
50 yrs of P’ship Tax
No P’ship K Returns ----50/50

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)

ARE 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 tax
losses of approximately $600 million, while generating only
about $8 million in actual losses
• Boca’s Partnership Agreement: (1) “…for the determination and
maintenance of capital accounts”; (2) that liquidating distributions
were to be made in accordance with the partners’ positive capital
account balances; and (3) that any partner with deficit balance
required to restore deficit balance in a timely manner (i.e., a DRO).”

No Ref. NOTE: NEW PROP. REGS.: EXPAND
to 704 OPPORTUNITIES FOR REVALUATION—
SHOULD INCORPORATE INTO OUR
AGREEMENTS!

TAX BLIND SPOT
LEAVING YOUR CLIENT OUT IN THE COLD, WHEN NO
704(C) METHOD IS ADOPTED

• Failing to address
what type of 704(c)
method to adopt may
not be prudent since:
– Property may have
been contributed
– Revaluations can
occur at any time
• Who is your client?


TAX BLIND SPOT
Who is Your TMP?

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

– Extension invalid if TMP suffers from
disabling conflict of interest
– TMP must be “owner”


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
Indeck Power
No Increased 100% Debt Allocation Equip. Co.
Basis!!! (Basis)
No Mr. Forsythe (TMP) Indeck Energy
Guarantee 100% (S Corp)
K-1
Indeck Overseas, Inc. Personal
K-1 1 Unit (1%)
(S Corp) Guarantees
MANAGER (WaivingAll
K-1 Rights of
RECOURSE
DEBT Subroga
99 Units IPO II, tion)
(99%) LLC $9.4 Million
Chart. Aircraft P/N BANK
TEFRA To Purchase
Aircraft
($1,385,457)

Part VII
Watching for the Blind Spots in
Operations


BLIND SPOTS IN OPERATIONS
Fictitious Names
Disclosing Your True Identity

“What’s Your Name?”
“May I See Some Identification?”
“Who Do You Work For?”

Is NEWCO really still OLDCO?

C Now See
F 708 Merger
Regs.
N C&N
Law Firm
SAME EIN
FC&N
Law Firm
2 of the 3 partners form new firm
Since a sufficient part of the
State law: dissolution (1969) business continued to be carried
on, then the FC&N firm cannot be
considered to have been
terminated for tax purposes.
Neubecker v. IRS, 65 T.C. 577 (1975) Therefore, receipt of a few items by
F does not constitute a liquidation
of his interests in the p’ship.

Don’t Let the Form of the Transaction Hide a COI Issue

Limited
14.5 Guarantee
mil.
(rec)

Huntington Bank
The Clearwater Tower
MIDLAND MUTUAL LIFE INS.
MAS ONE GENERALS JV $2.5 mil. Cap
guarantee, plus
GP Debt Serv.
MAS ONE
LTD. P’SHIP guaranty of all
interest
Mas One Ltd. P’ship v. U.S., 92 AFTR
2d 2003-XXXX (S.D.Ohio 2003)

BLIND SPOTS IN OPERATION

Proceeds: $4.1 mil

The Clearwater Tower
IS SOLD ON 12/29/94
Huntington Bank

MAS ONE GENERALS JV MIDLAND MUTUAL LIFE INS.
12/28/94 12/29/94
12/27/94 (After
NOTICE OF
1% abandoning
GP ABANDONMENT
OF LP INT. INCOME LP int, pays
1105 CORP off loan at
MAS ONE $8.3 million)
Admitted
as LP LTD. P’SHIP
Mas One Ltd. P’ship v. U.S., 92 AFTR 2d 2003-XXXX (S.D.Ohio
2003)(WILL NOT QUALIFY AS A CAPITAL CONTRIBUTION!!)


12/29/94
Even if it were (After
a capital cont., abandoning
then a deemed
LP int, pays
distribution to GP
off loan at
$8.3 million) Huntington Bank
MIDLAND MUTUAL LIFE INS.
MAS ONE GENERALS JV
12/28/94 COURT:

12/27/94 NOTICE OF Why
1% ABANDONMENT CAP would
GP OF LP INT. Midland
CONT.
1105 CORP pay more
MAS ONE than it
Admitted Assumed Debt owed?
LTD. P’SHIP
as LP
Mas One Ltd. P’ship v. U.S., 92 AFTR 2d 2003-XXXX (S.D.Ohio
2003)(WILL NOT QUALIFY AS A CAPITAL CONTRIBUTION!!)

More on COI Issues
AMERICAN RECOVERY AND REINVESTMENT
ACT OF 2009

NEW
I.R.C. Sec. 108(i)

Applicable Debt Instrument
The 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?


Getting Sloppy with the Purported DRE/SPE

• Evaluating Hybrid
Financing—The Tax If Equity, then….
Issues Tax
Pandemonium
– Equity Kickers
(Interest Enhancers):
Is lender de facto
partner?
• Convertible Debt Let the
Instruments
Reallocations
• Options Begin!!!!!
• Shared Appreciation
Mortgages
• Irrevocable Lines of Credit
• Demand Notes NEW: Prop.Regs.-Noncomp. Options
with Anti-Abuse Rule!!!!!

Watch Out for Noncompensatory (and Compensatory)
“Options”
LOAN: $10,000
5 YEAR NOTE;
CLASS A
INT. OF $1000/YR JS
MEMBER
LENDER

$10,000
Loan Document
100 Units
JS has the right to
CLASS A convert debt into
$10,000
MEMBER 100 LLC units (with
100 Units LLC full rights to capital,
profits, losses)

Prop. Regs. 1.721-2(d) “Noncompensatory Option” means a call option or
warrant, the conversion feature of convertible debt, or the conversion
feature of convertible equity (i.e. preferred equity convertible into common)

Watch Out for Noncompensatory (and
Compensatory) “Options”
Allocations of Net Income: $2,000/yr for 3 yrs

Capital A/C
JS
LENDER
CLASS A
MEMBER
10,000 Initial Loan Document
3,000 Alloc. 50% JS has the right to
13,000 after 3 convert debt into
CLASS A $30,000 100 LLC units (with
MEMBER full rights to capital,
50% profits, losses)
10,000 Initial
3,000 Alloc.
Equipment

13,000 after 3 Dep./15 yrs.

Watch Out for Noncompensatory (and
Compensatory) “Options”
In year 4, JS Lender “converts” debt into 100 LLC Units
Capital A/C
CLASS A JS
MEMBER LENDER

10,000 Initial
Under Prop. Regs.,
3,000 Alloc. $ 12,000
Lender’s capital account is
13,000 after 3 50% Plus, Equip. equal to the AB of the debt
CLASS A FMV: 30,000 right conversion
MEMBER AB: 24,000 ($10,000), plus any
accrued, unpaid qualified
10,000 Initial 50% stated interest. Plus,
3,000 Alloc. Lender gets the right to
receive LLC capital equal
13,000 after 3 to 1/3, or $15,000 ($45/3)

How to Classify a Land Trust for Federal Tax
Purposes?

• Focus on beneficial ownership
• Medlin v. IRS, T.C.Memo 2003-224 (7/29/03)
– (taxpayer not allowed to claim that property held in a
Florida land trust was really a partnership for federal
tax purposes; relationship never rose above mere
coownership)
• Are there two or more beneficial interest
holders?
– 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)


DEVELOPER BY ATTRIBUTION PROBLEMS

Blackhawk Builders, Inc. Subdivides into 77 lots

Building & selling houses to the public Agreement
since 1941
22 acres more Any Unsold
of Farm acres Lots
C/S
H-H Ranch, Inc. Will be Re-
Elgin Farm conveyed

Heise Brothers Realty, Inc.
AGENCY!!!!

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

HOW INVESTMENT COMPANIES MAY BLOW A 1031
UNDER THE “HELD FOR SALE” STANDARD

NOTE:
Taxpayer
Company’s Books: argued that
Classified its original
Lots as W-in-P intent
(acquire
property to
subdivide)
NEAL T. BAKER ENTERPRISES, INC. v. had shifted
IRS, T.C.Memo 1998-302 to one of
investment
Operator of fast-food restaurants was found to have
held 48 lots “primarily for sale” and therefore, did not
qualify for 103 treatment on sale.
must manifest
change clearly

Watching Out for Related Party Transactions

707(b)(1)(A) – No loss if: 267(c) att.
Sale/Exchange rules
TP
P’ship

If TP owns, directly/indirectly,
greater than 50% of profits
707(b)(1)(B) – No loss if: OR capital

Sale/Exchange
P’ship P’ship

LOSS LIMITATION—RELATED
PARTY RULES © 2009 T. Scott Tufts, Esq. 107

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

267(c) att.
Sale/Exchange rules
TP
P’ship

707(b)(2)(B) – Any gain OR capital
will be ORDINARY if:

Sale/Exchange
P’ship P’ship

CG DISALLOWANCE—
RELATED PARTY RULES © 2009 T. Scott Tufts, Esq. 108


• Section 1239 – Any gain will be ORDINARY if:
Sale or
exchange of
depreciable any “controlled
property entity”
TP
P’ship

OR capital

– OR –
Any “related person as
Defined under 1239(b)


Part VIII
Watching for the Blind Spots in Tax
Returns and Disclosure Issues


Part IX
Watching for the Blind Spots When Tax
and State Law Go in Different Directions


ASYMMETRICAL TRANSACTIONS

LLC
STATE
LAW

S CORP
LLC FED TAX
LAW

S CORP
ELECTION IRS FORM 1120S


Part X
Watching for the Blind Spots in
Convertibility, Entity Transitions,
Mergers and Divisions


Convertibility
• Many states now have very broad entity
conversion features for corporations, LLCs,
LLPs, etc.
• State law merger statutes not binding on
Federal tax law
• Easy to go from LLC to S or C corporation,
but much more difficult to go from a C to a S
corporation
• Converting Corp to LLC results in liquidation
of Corp.

BLIND SPOTS
WHEN PURCHASING AN INTEREST FROM THE
OWNER OF A SINGLE-MEMBER LLC

• Rev. Ruling 99-6
State Law Tax Law – 708
Continuing Entity Termination

100% LLC
Assymmetrical
Transactions Lawyer
Purchasing “for the deal” Selling
Member Members


TAX BLIND SPOT
WHEN PURCHASING AN INTEREST FROM THE
OWNER OF A SINGLE-MEMBER LLC

• Rev. Ruling 99-5
100%
State Law
-75%
Continuing Member
25%

75%
Single-Member
Assymmetrical LLC
Transactions Lawyer
Purchasing “for the deal” Continuing
Member Member


BLIND SPOTS
Is NEWCO really still OLDCO?

C Now See
F 708 Merger
Regs.
N C&N
Law Firm
SAME EIN
FC&N
Law Firm
2 of the 3 partners form new firm
Since a sufficient part of the
State law: dissolution (1969) business continued to be carried
on, then the FC&N firm cannot be
considered to have been
terminated for tax purposes.
Neubecker v. IRS, 65 T.C. 577 (1975) Therefore, receipt of a few items by
F does not constitute a liquidation
of his interests in the p’ship.

BLIND SPOTS
International Planning

U.S. Partners Foreign Partners

The Partnership
Agreement

Partnership
The Agreement
Cap. Accounts
Section 704(c)
P’ship elections
Etc.


Part XI
Some Ethical Considerations in
Dealing with the Blind Spots


Unprotected Business Matters vs. Protected Legal Advice
by 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)

Who is Your Client?
M.R. 1.13
Organization
as a Client
Closing
Attorney

Partnership

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

What Hat Are You Wearing?
“Lawyer”

Tax Advisor

“Business Advisor”


BLIND SPOT
When the Preliminary Discussions with the
CPA Bite You and Your Client (G-I Holdings)
• 1990:
• Preliminary Discussions
Held to Conduct Sale of 2
Subsidiaries by GAF
Corp. to Rhone-Poulenc
Surfactants & Specialties,
Ltd.
McKee, Nelson Under Siege
• Tax Advisors:
– McKee Nelson
– Arthur Andersen


BLIND SPOT
CPA Bite You and Your Client

McKee, Nelson
ALKARIL CHEMICALS,
Issues tax opinion
Inc.
GAF CHEMICALS letter
CORP. This “should” work!!
$26 Million
(G-I Holdings, Inc.) Equity Stake
1990 “721”
LP
Rhone-Poulenc
Surfactants &
GP Specialties, LP
RHONE-POULENC
Given the right to retire 98% of
SURFACTANTS & GAF’s p’ship interest, but only after
SPECIALTIES, INC. expiration of 3-year TAX
DISGUISED SALE RULE PERIOD


BLIND SPOT
CPA Bite You and Your Client

ALKARIL CHEMICALS, IRS: PROOF OF CLAIMS FOR
Inc. G-I HOLDINGS: $400 MILLION
File for
Bankruptcy ACI: $530 MILLION, PLUS
MILLION
GAF CHEMICALS
CORP. PENALTIES OF $49 MILLION

(G-I Holdings, Inc.)
LP
Rhone-Poulenc
Surfactants &
GP Specialties, LP
RHONE-POULENC IRS: 1990 TRANSACTION WAS A TAXABLE DISGUISED
SALE OF PROPERTY BY GAF TO EITHER THE LP, OR
SURFACTANTS & THE GP UNDER 707(a). ALTERNATIVELY, LP WAS NOT
SPECIALTIES, INC. A VALID P’SHIP, OR IF IT WAS, GAF WERE NOT VALID
PARTNERS FOR TAX PURPOSES.


Watching Out For the Blind Spots of Partnership Tax Vehicles

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