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ADVANCED
TAX ISSUES FOR LLC?S
A.
Examination of the Check-the-Box Regulation
Effective January 1, 1997, the IRS
issued final regulations that implemented the entity classification
system. These "Check-the-Box" rules allow unincorporated
organizations to elect to be treated as either corporations or partnerships
for federal income tax purposes. Certain business entities that
are excluded from these rules are corporations organized under state
statutes, foreign entities that resemble U.S. corporations, entities
taxable as corporations under special Code provisions, and trusts.1
An
entity that does not elect a particular classification is classified
under the default rules
that state for federal tax purposes, non-corporate domestic organizations
with more than one member are treated as partnerships, and single-member
domestic entities are disregarded.
There
are three steps that must be performed in order to determine if you
qualify to choose your entity.
1.
Identifying Separate Entities
We
must first determine if the organization is a separate entity.
The ?business entity? concept is the basis of the ?Check-the-Box?
rules. The federal tax law determines if the entity is separate
from its owners for federal tax purposes and does not depend on the
organization recognized as a separate entity under local law.2
"Business entity" is defined by the regulations as any entity
recognized for federal tax purposes that is not classified as a trust
or subject to special treatment under the Code.3
Single-Owner Organizations
Proprietorships
A
disregarded entity is a business entity that is not a corporation, has
a single owner, and is disregarded as an entity separate from its owner.4
The check-the-box regulations allow a single owner to elect to be disregarded
as an entity separate from its owner. The disregarded entity may
retain its entity status for state law purposes, but is disregarded
for federal tax purposes.
Community
Property Entity
The
IRS has stated it will respect the taxpayers? choice of the entity
as either a disregarded entity or a partnership in the case of a qualified
entity owned exclusively by a husband and wife as community property.
This qualified entity is a business entity entirely owned by a husband
and wife as community property under the law of a state, is not treated
as a corporation, and one in which no other person would be considered
an owner for tax purposes.5
Partnerships
The
definition of a business entity other than a corporation is based on
the number of members. A "partnership" means it is a
business entity with at least two members and is not a corporation.6
Corporations
An entity meeting the description in
any of the following eight categories is classified as a corporation
for federal tax purposes:7
(1)
a business entity organized under a federal or state statute, or under
a statute of a federally recognized Indian tribe, if the statute describes
or refers to the entity as incorporated or as a corporation, body corporate,
or body politic;
(2)
an association;
(3)
a business entity organized under a state statute, if the statute describes
or refers to the entity as a joint-stock company or joint-stock association;8
(4)
an insurance company;9
(5)
a state-chartered business entity conducting banking activities, if
any of its deposits are insured under the Federal Deposit Insurance
Act or a similar federal statute;10
(6)
a business entity wholly owned by a state or any political subdivision
thereof;
(7)
a business entity that is taxable as a corporation under a provision
of the Code other than §7701(a)(3); or
(8)
a business entity formed in one of numerous designated foreign jurisdictions.
2. Eligible Entities
The second step is to determine whether
the entity qualifies as an "eligible entity." Only the
"eligible entity" may elect the federal tax classification
it wishes. The definition of an "eligible entity" is
a business entity that is not classified as a corporation under Regs.
§301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8).
Entity
with Two or More Members
An
eligible entity having two or more members has the option of electing
classification as either an association or a partnership.11
Single-Member
Entity
A
single member eligible entity can elect to be classified as an corporation
or as a disregarded entity separate from its owner.12 An entity electing to be disregarded,
will be treated as a sole proprietorship.
Default
Classification Rules
An
eligible entity will be classified under the default rules if it does
not elect its desired entity classification. Unless
the ?eligible entity? elects otherwise, it will be classified as
a disregarded entity if it has a single owner or a partnership if it
has two or more members.13
3.
Elections
There are only two situations that
require an eligible entity to file a classification election.14
The first situation is if the entity wishes to be classified differently
than it would be under the default rules. The second situation
is if the entity wishes to change its classification.
Election
Procedure
In order to make a classification election,
an eligible entity must file Form 8832, Entity Classification Election.15
A copy of Form 8832 must be attached to the federal tax or information
return of the entity for the taxable year for which an election is made.16
Where an entity is not required to file a return for the year an election
is made, a copy of the Form 8832 must be attached to the federal income
tax or information return of all direct or indirect owners of the entity
for the taxable year of the owner that includes the date on which the
election was effective.17 Failing to attach a copy of
a Form 8832 to the return will not invalidate the election.
An
election must be signed by either (i) each member of the electing entity
who is an owner at the time the election is filed, or (ii) an officer,
manager, or member of the electing entity who is authorized to make
the election.18
An entity that has an employer identification
number (EIN) will keep their EIN even if their entity's federal tax
classification changes under Regs. §301.7701-3.19 A single owner disregarded entity
under must use the owner's taxpayer's identifying number (TIN) for federal
tax purposes.20
When a single owner entity's classification changes and becomes
recognized as a separate entity for federal tax purposes, that entity
must use the EIN, not the TIN of the single owner.
An election is effective either on
the date specified on Form 8832 or on the date the election is filed.
A specified effective date will be allowed as long as it is not more
than 75 days before the filing date or more than 12 months after the
filing date. A specified date more than 75 days before the filing
date will be effective only 75 days before the filing date. A
date specified more than 12 months from the filing date will be effective
12 months after the filing date.21
Restriction
on Classification Changes
An
eligible entity that elects to change its classification cannot change
its classification by election again during the 60 months following
the effective date. The IRS has the authority to waive the 60-month
restriction if more than 50% of the ownership interests in the entity
on the effective date of the election are owned by persons that did
not own any interests on the filing date or on the effective date of
the entity's prior election.22
Only
an election to change classification will begin a 60-month waiting period.
If a new eligible entity elects out of its default classification effective
from the beginning, that election is not a change in the entity's classification
and does not prevent the entity from changing its classification by
election within the next 60 months.
Changing
The Status Of Entities
Organizations
that are eligible and wish to change their classification may do so
by filing an election. Once the classification has changed, the
organization must keep that classification for at least five years.
Potential
Tax Impact on Changing Classification
A
change in tax classification will have tax consequences.
Corporation
Status Elected
When
a partnership elects to be classified as a corporation, it will be considered
to have contributed all of its assets and liabilities to the corporation
in exchange for stock in the corporation.23 The partnership is deemed to
liquidate by distributing stock in the corporation to its partners.
Election
by Disregarded Entity to Be a Corporation
If
a disregarded entity elects to be classified as a corporation, the owner
of the eligible entity is considered to contribute all of the assets
and liabilities of that entity to the corporation in exchange for stock
of the corporation.24
Changing
from Corporation to Partnership Status
When
a corporation elects to be classified as a partnership, it is considered
to liquidate by distributing its assets and liabilities to its shareholders.
The shareholders are deemed to contribute all of the distributed assets
and liabilities to the partnership.25
Corporation
or Partnership Elects to Be Disregarded Entity
When
a corporation elects to be a disregarded entity, the corporation is
deemed to have liquidated by distributing its assets and liabilities
to its sole owner.26
If an LCC classified as a partnership becomes a single member LLC,
the partnership status terminates.
The
IRS issued guidance in Rev. Rul. 99-627 on an LLC classified as a partnership
that becomes a single member LLC. The IRS ruled that §708(b)(1)(A)state
the LLC's partnership status will terminate since the operations of
the partnership are no longer carried on by any of its partners as a
partnership. If no election is made to treat the LLC as a corporation
for federal tax purposes, the LLC then becomes a disregarded entity.
Changing
from Single Member Disregarded Entity to Partnership
A
single member disregarded entity may sell an interest in that business
and become a partnership. Both partners should treat the conversion
of a single member entity to a multiple member entity as §721 contributions
to the entity.
The IRS issued
guidance on the conversion of a single member LLC that is a disregarded
entity to a partnership in Rev. Rul 99-5.541. Section 721(a) states
no gain or loss is recognized by the previous sole owner or the unrelated
purchaser as a result of the conversion to a partnership.
B.
Compensation Planning and Use of Guaranteed Payments, Distributive Shares
and Keogh Plans
Guaranteed
Payments
The
payment to a partner for services or the use of capital that is determined
without regard to the income of a partnership is classified as a guaranteed
payment and generally is treated as non-partnership transaction.28
The partner includes the payments in income using the same standards
as a non-partner.29 The partnership may be permitted
to deduct the guaranteed payment.30 The guaranteed
payment is treated as an ordinary partnership transaction.
Deferred
Compensation Arrangements
A
nonqualified deferred compensation plan is a contractual arrangement
between employer and employee providing for the deferred payment of
compensation in the future. An effective deferral requires avoiding
constructive receipt.
An
LLC member's distributive share of the LLC's income and losses cannot
be "deferred." 31 These items pass through
to the LLC member under §702 and are taxable. Special allocations
can be made in the LLC operating agreement to allocate certain items
away from specific LLC members if the other partners agree.
It
is possible to set up a nonqualified arrangement to defer the guaranteed
payments the LLC member is to receive under §707(c). Reg. §1.707-1(c)
states these payments will be ordinary income that is taxable to the
member. Because of the deferred compensation arrangement between
the LLC and the member, the LLC may control when the payment is made.
The deferred amounts will increase the distributable income of the LLC
members based on the LLC agreement to allocate income. Since the
member cannot defer his allocable share of LLC income, a portion of
the deferred income will flow through to him in the year of deferral.
Equity
based compensation is used by many corporate employers to motivate their
employees. An LLC can transfer an interest to an employee or existing
member in the form of a capital and profits interest, a capital interest,
or a profits interest, or as an option to acquire either a capital or
profits interest or both.
Options
to Acquire LLC Interests
LLCs
can issue nonqualified options to purchase LLC units. The grant
of an option to purchase LLC units to either to an existing member or
an employee does not have a taxable consequence for the LLC. It
would be treated as a guaranteed payment. The difference between
the fair market value of the option and the strike price would be a
"payment" in the year received or the year the restriction
lapses. This creates a deduction for the LLC and income to the
LLC member.
Distributive
Shares
Another alternative form of distribution
from an entity to the owner is the distribution of ownership units in
the entity, or of rights or options to acquire units in the entity.
This type of distribution may be treated as an ordinary income distribution
of property, but in some cases it may be treated as a nontaxable distribution
of unit interests.
Partnership
Unit Distributions
A partnership or limited liability
company treated as a partnership may distribute ownership units to its
partners.
(1) The
partnership may reallocate the ownership percentages between the partners
because of new partners, the retirement of partners, or an agreement
between the partners to alter their interests.
(2) When
the partnership has multiple levels of partnership interests, the partners
at one level may receive additional interests and the partners at another
level will not receive any additional interests, which will cause a
reduction of their percentage interests in the partnership.
(3) Some
partners may receive interests in the same partnership tier and other
partners may receive interests in a higher or lower tier. The
income tax results will be dependent on whether the partnership interests
being adjusted are income interests or capital interests.
Changes in Income Interests
Any
change in income interests is recognized in the year the partner recognizes
his distributive share of the partnership profits. The amount
recognized shows the change in the income interests.
Changes in Capital Interests
The
acceptance by a partner of an additional capital interest in the partnership
may be treated as an income event, the receipt of a gift from another
partner, or be classified in accordance with its economic consequences.
Partnership Distributions
Cash
or property distributions received by a partner from a partnership will
reduce the partner's basis in his interest. Unless the cash distribution
is in excess of the basis, it will usually not be a taxable event to
the partner or the partnership. Property distributed to a partner
takes the same basis and holding period it had in the partnership.
Cash distributions will reduce the partner's basis in his interest dollar
for dollar.32 Gain is recognized by the distributee
partner only if the cash received exceeds his basis in his interest
before the distribution.33 Gain recognized is taxed as gain
from the sale or exchange of a partnership interest.34
Distributions of non-cash property will reduce the partner's basis in
the partnership interest to the extent of the adjusted basis of the
property in the hands of the partnership.35
Non-Liquidating
Distributions
A
partner does not recognize loss in a non-liquidating distribution.36
A partner also does not recognize gain as a result of a non-liquidating
distribution, unless the amount of cash is greater than the partner's
outside basis.37 Cash distributed up to the amount
of the basis represents amounts the partner has already accounted for
under the income tax system.
Only cash distributions in excess of outside basis represent income
for the partner.
A
partner does not recognize gain with respect to property distributions
in a non-liquidating distribution, The partner's previously unrecognized
gain or loss in the partnership interest is preserved by allocating
the adjusted basis to the distributed property and making a reduction
to the partner's basis. The basis of the distributed property in the
partner's hands is the same as the basis of the property in the partnership's
hands. But it can not be greater than the partner's adjusted basis
in the partnership.38
Since
the goal is to preserve the partner's tax position in regard to the
partnership investment in a non-liquidating property distribution the
partner's basis is reduced by the amount of money distributed, and the
adjusted basis of the distributed noncash property. 39
The partner is treated as having converted a single asset, a partnership
interest, into multiple assets, the partnership interest, the distributed
property, and the distributed money, and the partner's basis is divided
among these assets.
Keogh
Plans
Much of the planning concerning the
use of and choice between different taxable entities has evolved from
the historic differences between the treatment of employees and self-employed
individuals for purposes of tax qualified retirement plans. H.R.
10 or "Keogh" plans are the income deferral arrangements most
commonly used by self-employed individuals.
The
Tax Equity and Fiscal Responsibility Act of 1987 (TEFRA) made modifications
that included "top heavy plan" limitations. As a result,
tax qualified retirement plan choices are now a neutral factor in the
decision concerning the choice of entity.
The
maximum amount that is deductible for a retirement plan contribution
is limited to the individual?s net self-employment income when made
by an unincorporated entity.40
In the case of a defined benefit plan,
these rules apply when more than 60% of the benefits are the benefit
of key employees.41 The term "key employee"
includes certain officers, a 5% or greater owner of the employer, a
1% owner of the employer having a high income level from the employer,
and self-employed individuals.42
Other LLC
Compensation Issues
The
use of LLC interests to compensate LLC employees may result in the employees
being treated as members of the LLC rather than as employees for federal
tax purposes. There is a difference in the treatment of compensation
paid to an employee and compensation paid to a LLC member.
Employee
or Member
Section
707(a) states that if a partner engages in a transaction with a partnership
other than in his capacity as a member of such partnership, the transaction
will be considered as occurring between the partnership and one who
is not a partner. It is possible an LLC member could be classified
as an employee if he provided services and there was a related allocation
or distribution to him.
If
payments are made to a partner for services, without regard to partnership
income, under §707(c) the partnership deducts such amounts and the
partner has ordinary income.
Compensation
to a member must be analyzed to determine the relationship between the
member and the LLC for tax purposes. The following five factors
must be considered:
? Entrepreneurial
risk. Whether the payment is subject to entrepreneurial risk.
An employer-employee relationship would be supported by a lack of entrepreneurial
risk.
?
Transitory status. Whether partner status is transitory.
?
Timing. Whether the payment closely follows the performance of
service.
? Relative
size. Whether the recipient's interest in the partnership is small
in relation to the payment or allocation in question.
C.
Planning for Self-Employment Tax
An
individual is subject to either social security tax as an employee,
or self-employment tax as an equivalent to the social security tax.
The employer is required to match the social security contribution of
the employee. The self-employed person is required to pay the
full cost of this tax.
Sole
proprietors, members of a partnership, and members of a limited liability
company treated as a partnership are subject to the self-employment
tax. The distributive share of partnership income
is included in a partner?s net earnings from self-employment.
A limited partner does not include the distributive share of partnership
income or loss from self-employment income. Unless a limited partner?s
distributive share of income or loss from the self-employment income
is received as guaranteed payments, it will not be included in his self-employment
income.43
It
is not clear how self-employment taxes apply to members of an LLC classified
as a partnership. The members are not either general partners
or limited partners. There are proposed regulations defining which
partners of a federal tax partnership are considered limited partners.
These regulations apply to all entities that are classified as partnerships
for federal tax purposes.
"Net
earnings from self-employment" includes the gross income derived
from any trade or business carried on by a sole proprietor or partner
in a partnership, less any deductions. §1402(a) Any partner's
share of income or loss from any trade or business carried on by a partnership
is also considered as net earnings from self-employment.
There
are exceptions to what must be included in self-employment earnings.
Some of the exceptions are:
A
limited partner's distributive share of income or loss is excluded from
self-employment net earnings. A limited partner's guaranteed payments
in exchange for services are subject to the self-employment tax.44
When a partner is a general and a limited partner, only the general
partnership income and loss is subject to self-employment tax.45
Proposed
regulations define which partners are considered limited partners for
purposes of §1402(a)(13). They are to apply to all entities classified
as a partnership for federal tax purposes.46 The same
standards will apply when determining the status of an individual owning
an interest in an LLC. The proposed regulations will adopt an
approach that depends on the relationship between the partner, the partnership,
and the partnership's business.47
The
proposed regulations will treat an individual as a limited partner unless
the individual has personal liability for the debts of, or claims against,
the partnership because he is a partner; has authority to contract on
behalf of the partnership; or participates in the partnership's
trade or business more than 500 hours during the year.48
If substantially all of the activities of a partnership involve the
performance of services in the fields of health, law, engineering, architecture,
accounting, actuarial science, or consulting, the proposed regulations
state an individual will not be considered a limited partner.49
An
individual who is not a limited partner is allowed to exclude from his
net earnings from self-employment a portion of his distributive share
if he holds more than one class of interest in the partnership.50
The
Taxpayer Relief Act of 1997 added a provision that prevented the IRS
from finalizing these regulations until July 1, 1998.51
To date these regulations have not been finalized by the IRS.
Limited
Liability Companies, Limited Liability Partnerships, and Other "New"
Entities
The exclusion for limited partners
was incorporated into the statute at a time when there essentially were
only two types of partnerships, the general partnership and the limited
partnership. With the advent of limited liability companies, limited
liability partnerships, and other types of entities that are being treated
as partnerships for federal tax purposes, a great amount of confusion
has risen as to what type of partners may exclude their distributive
share of income or loss in determining net earnings from self-employment.
Case
Law
The first case to consider is Johnson
v. Comr.,52 This case involved the determination
as to whether the taxpayer's net income from oil and gas working interests
should be taxed as net earnings from self-employment. The taxpayer
argued that she was not involved in a trade or business and her role
was passive participation. The Tax Court held her involvement
in a trade or business to be irrelevant since she was a partner in a
partnership. The taxpayer also argued that if she is a partner,
she should be considered a limited partner due to her limited involvement.
The court rejected her argument stating "limited partnerships are
creatures of agreement cast in the form prescribed by State law ...
Petitioner's argument is not persuasive because she and the other working
interest owners did not take the necessary steps to comply with Texas
law.?53
The
partnership in Mammoth Lakes Project, et al. v. Comr. was a general
partnership. These taxpayers argued they were entitled to include
their share of net losses from the partnership in calculating their
net earnings from self-employment. The government argued that
there was limited liability and they did not participate in the management
of the partnership. The court considered the government's argument to
be a "superficially correct argument." Since the taxpayer
did not address that argument, the court considered the taxpayer to
have conceded the issue.
The
Tax Court in Perry v. Comr.,54 ruled on the
status of a person holding a working interest in an oil and gas venture.
The court rejected the taxpayer's argument that he should be treated
as a limited partner. The court stated, "State law requires
that certain formalities be observed to create a limited partnership
... There is no evidence of such formalities having been observed by
the owners of interests in the wells.?55
The
status of a passive state law general partner for SECA tax purposes
was ruled on by the Tax Court in Norwood v. Comr.56
The taxpayer previously had been an active partner in the medical supply
partnership. He had reduced his hours to only 41. He still
held a 50.95% capital and profits interest in the partnership.
He argued his interest in the partnership was passive and he should
not be subject to SECA tax on his partnership income. The court
rejected this argument. The court stated, "That petitioner
spent a minimal amount of time engaged in the operations of [the partnership]
is irrelevant ... Petitioner's lack of participation in or control over
the operations of [the partnership] does not turn his general partnership
interest into a limited partnership interest. A limited partnership
must be created in the form prescribed by State law."57
Structures For Avoiding SECA
Tax
S
Corporation Leases Worker to Partnership
A member forms an S corporation to
hold his or her interest in an LLC. The S corporation
would then employ the individual and lease him to the LLC. Because
the S corporation is not an individual, there is no SECA tax due with
respect to the S corporation's distributive share of the LLC's income
or the lease payments made for the individual's services. Employment
taxes are due on the individual's salary paid by the S corporation,
but the individual generally will take income from the S corporation
in part as salary and in part as a distribution. The distribution
of S corporation income is not subject to SECA or employment tax.
Segregate
Service and Capital Intensive Portions of Business in Two Separate Entities
A taxpayer's business with both service
and capital-intensive components may be segregated into separate entities.
D.
Transfer of Appreciated Property to the LLC
Changing
the Status of Entities
Election by
Disregarded Entity to Be an Association
When a disregarded
entity elects to be classified as an association, the proprietor of
that entity is considered to have contributed all of the assets and
liabilities of his entity to the association in exchange for stock of
the association.58
Changing from
Association to Partnership Status
When
an association elects partnership classification, the association is
considered to liquidate by distributing its assets to the shareholders.
The shareholders are considered to contribute all of the distributed
assets and liabilities to the partnership.59
Association
or Partnership Elects to Be Disregarded Entity
An association
that elects to be a disregarded entity is considered to liquidate by
distributing its assets and liabilities to its sole owner.60
When an LCC is classified as a partnership becomes a single member LLC,
the partnership status ends.
Changing from
Single Member Disregarded Entity to Partnership
A
disregarded entity may sell an interest in that business and become
a partnership. This conversion of a single member entity into
a multiple member entity resulting from the issuance to the new member
of an interest in the entity is considered Section 721 contributions
to the entity by both partners. No gain or loss is recognized
by either the previous sole owner or the new partner because of the
conversion to a partnership according to Section721(a).
Transfers of Property to New Entities
Partnership
There
is no gain or loss recognized to a partner on the contribution of appreciated
property to a partnership when exchanged for a partnership interest.61
The income tax basis of the transferred property is the tax basis to
the partner of the partnership interest acquired in the exchange.62
The
partnership does not recognize gain or loss on the acquisition of property
in exchange for a partnership interest.63 This property
has the same basis after transfer into the partnership as it had with
the transferor partner.
Limited
Liability Company
Contributions of property to an LLC
are governed by §721, which provide no gain or loss will result when
an LLC member contributes property to an LLC.
An
LLC classified as a partnership will have the same income tax consequences
as those for the formation of a partnership.
Converting
to LLC Status
An
existing business in the corporate form will find the tax burden imposed
on a complete conversion to LLC status formidable. Partnership
conversions to an LLC may be structured with no serious tax liability.
Converting a proprietorship to an LLC may also occur without the imposition
of tax.
Existing
C Corporations
Sections 331 and 336 require the shareholders
and the corporation to recognize the gain on the distribution of corporate
property to the shareholders when liquidated. This is a double
tax that is a very high a price to pay for converting to LLC status.
The double tax exposure will prove the corporate-to-LLC conversion to
be economically impractical.
Form
of Conversion
A
corporation may be converted to LLC status by having the corporation
form an LLC entity, transfer the corporation's assets to the LLC, and
then liquidate the corporation out of existence. The shareholders
would receive LLC interests in exchange for their stock. This
is a physical transfer of assets. In many states there is an alternative.
The physical transfer of assets may be avoided by a "conversion"
from corporate to LLC status. This "conversion" requires
filing with the state that the corporation is converting to LLC status.
The advantage is the assets are not transferred and do not need to be
retitled. The filing puts the public and creditors on notice the
corporation has merely changed its business form.
There
are three ways to accomplish an actual transfer. They are: liquidate
the corporation and contribute the assets into a new LLC; have the corporation's
shareholders form a new LLC, contribute their corporate stock to the
capital of the LLC, and liquidate the corporation into the LLC; and
formation of an LLC by the corporation with a contribution in of its
assets, followed by a liquidation of the corporation's LLC interests
to its shareholders.
Existing
S Corporations
An
existing S corporation may subject its shareholders to tax if it liquidates
in order to transfer its business into an LLC. Gain will be recognized
at the corporate level on any appreciated property and this gain will
flow through to the shareholders.
The
same three alternatives are available in re-forming an S corporation
as an LLC: liquidate the corporation and contribute the assets into
a new LLC; have the corporation's shareholders form a new LLC and contribute
their stock which is then liquidated into the LLC; and the formation
of an LLC by the corporation followed by a liquidation of the corporation's
LLC interests to its shareholders.
The IRS has
ruled that if the transfer of all of an S corporation's assets and liabilities
into a new LLC qualified as a reorganization under §368(a)(1)(F),
and the LLC met the requirements of an S corporation under §1361, the
reorganization will not terminate the corporation's S election and the
S election will apply to the LLC.64
Liquidation-Reformation
as LLC
Changing
the corporate business form to that of a limited liability company is
becoming a more frequent transaction. Because of the double taxation
issues, changing the corporate form to LLC status generally does not
occur if the corporation is a stand-alone entity.
These
transactions require either the liquidation of a corporate subsidiary,
a merger under state law into an LLC, or a "conversion" of
the corporate subsidiary into an LLC.
All three transactions result in the same tax consequences. The
corporate subsidiary is treated as actually liquidated. The liquidation
is considered a non-recognition transaction under §§332 and 337.
This assumes the corporate subsidiary is solvent and at least 80% or
more owned by the parent corporation. The subsidiary's assets
are not stepped up to fair market value because the §332 liquidation
is a non-recognition transaction.
In
an actual liquidation, the subsidiary assets are physically transferred
twice, first to the corporate parent and second to the LLC. The
second transfer is ignored for federal income tax purposes if the LLC
is completely owned by the parent corporation and treated as a disregarded
entity. This transfer of the assets to the LLC is treated as a
§721 formation of a partnership.
When
a corporate subsidiary is either merged into the LLC or converted LLC,
a §332 liquidation is considered to have occurred with tax results
the same as in an actual liquidation.65 In a merger,
the assets are transferred once. In a conversion, the assets are
not transferred. If the LLC has more than one member and is treated
as a partnership, the assets will be considered contributed to the LLC
in a §721 partnership formation without gain recognition.
Converting
Partnerships to LLCs
Converting
an existing partnership to an LLC can be accomplished by contributing
existing partnership interests to a newly formed LLC in a tax-free §721
contribution.66 The partnership would end under §708(b)
resulting in a liquidation of the partnership's assets into the LLC.
This transaction is usually allows non-recognition treatment.
Termination
of Existing Partnership
Rev. Rul. 95-37
states that no §708 termination of the partnership has occurred because
the formation of an LLC is considered a §721 transaction. The
contribution of a partnership interest to another partnership is not
considered a sale or exchange of an interest in the first partnership.67
The partnership is not terminated, therefore, no liquidation is considered
to have occurred. The partnership may continue for tax purposes
in LLC form.
The
conversion is determined to be a non-recognition transaction under §721
if the conversion does not change ownership interests in profits, losses,
or capital. Rev. Rul. 95-3768
states the conversion of an existing partnership into an LLC is a non-event
for tax purposes.
E. Death or Retirement of a Member and Tax Alternatives
Several issues are raised by the retirement
or death of a partner. First, the retired partner or the deceased
partner's estate receives payments in liquidation of the partner's interest.
These payments are generally treated as distributions by the partnership
to the partner.69
Except in the case of general partners in which capital is not a material
income-producing factor.70 Distribution treatment will
apply except in the case of the death or retirement of a general partner
in service-oriented partnership. Distribution treatment will apply
to all payments except for those on account of (1) unrealized receivables,
and (2) the value of the partnership's goodwill.71
These are treated as either an allocation of partnership income or a
guaranteed payment.
Second,
the person who inherits a partnership interest generally adjusts the
outside basis to reflect its fair market value at the time of the partner's
death. The death of a partner triggers an inside basis adjustment
for the persons who inherit the partnership interests in the same manner
as if the partnership interest had been sold if a partnership has made
an election to adjust inside basis to reflect distributions and dispositions.
Alternatives
Upon Death or Retirement
Four
alternatives are available to a partner who wishes to retire from active
participation in a partnership and for the successors of a deceased
partner. These four alternatives have different federal income
tax consequences. The alternatives are as follows:
1.
The partnership liquidates the partner's interest either for a lump
sum distribution or for payments over time and the remaining partners
continue the operations of the partnership.
2.
The remaining partners purchase the deceased or retiring partner's interest
either for a lump sum or for payments over time.
3.
The deceased or retiring partner's interest is sold to a third party.
4.
The partnership is terminated, and the partnership interests of all
partners are liquidated.
If
the partnership agreement so provides, the successors of a deceased
partner continue as partners and share in partnership profits and losses
on an ongoing basis.
If a partner withdraws from a partnership
by retiring or if the interest of a deceased partner is liquidated,
and successors receive one or more payments from the partnership in
liquidation of the partnership interest, §736 applies to the payments.
The
purpose of §736 is to classify payments to a withdrawing partner.
Section 736 does not determine the tax consequences. Once the
liquidating payments to a withdrawing partner are classified, other
provisions of subchapter K govern the tax consequences to the withdrawing
and continuing partners.
Section 736
generally classifies payments from a partnership to a withdrawing partner
as: (1) payments in consideration for the withdrawing partner's interest
in partnership assets (§736(b)); (2) a distributive share of partnership
income (§736(a)(1)); or (3) a guaranteed payment (§736(a)(2)).
The
characterization of payments from a partnership to a withdrawing partner
is significant because it determines: (1) whether the withdrawing partner
recognizes capital gain or loss or ordinary income with respect to the
payments; (2) the timing of the gain, loss or income recognition by
the withdrawing partner; (3) whether the partnership is entitled to
a deduction with respect to the payments; and (4) whether the remaining
partners are entitled to an exclusion from their own share of partnership
income with respect to the payments. Classification under §736 determines
whether the amounts paid to the successors of a deceased partner constitute
income in respect of a decedent under §§691 and 753.
§736
Section
736 applies, according to its terms, to "payments made in liquidation
of the interest of a retiring partner or a deceased partner."
Section 761(d) states that the term "liquidation of a partner's
interest" means the termination of a partner's entire interest
in a partnership by means of a distribution, or a series of distributions,
to the partner by the partnership. The term includes a series
of distributions whether they are made in one year or in more than one
year as long as the partner's entire interest is ultimately to be terminated.72
Section
736 applies to payments by the partnership which are (1) in liquidation
of the entire interest (2) of a retiring or deceased partner.73
A partner is considered to have retired when he ceases to be a partner
under local law.74 Although a partner may cease to be considered
a partner under local law, he continues to be a partner for purposes
of subchapter K until his interest in the partnership is completely
liquidated.75 In order for §736 to apply to payments from
a partnership to a withdrawing partner, the withdrawing partner must
have ceased being a partner for local law purposes at the time of the
payment. Partnership distributions in partial liquidation of a
partner's interest are classified as current distributions subject to
§731 rather than liquidation payments subject to §736.76
. Section 736
does not apply to a sale by one partner of his partnership interest
to one or more of the remaining partners. The economic consequences
to both the withdrawing partner and the continuing partners may be identical
whether the withdrawing partner is bought out by the partnership or
by all of the remaining partners. Nevertheless, §736 applies to the
former but not to the latter.77 If the estate or other
successor in interest of a deceased partner continues as a partner in
the partnership, §736 does not apply to payments from the partnership
to the deceased partner's successor.78 If one partner
in a two-person partnership withdraws, §736 applies to payments made
from the partnership to the withdrawing partner in liquidation of the
withdrawing partner's interest and the partnership will not terminate
for federal income tax purposes until the final §736 payment is made.79
With
the withdrawal of one member of a two-person partnership, the parties
should be particularly careful in the manner that payments to the withdrawing
partner are made. If §736 treatment is desired, the partnership
agreement should provide the payments be made from the partnership in
liquidation of the withdrawing partner's interest and all payments should
be made from funds of the business rather than from the separate funds
of the remaining partner. The §736 payments to the withdrawing
partner should be reflected in the books of the continuing business.
These precautions are suggested because, upon the withdrawal of one
of two partners, the "partnership" continues as a federal
income tax fiction as long as §736 payments are made to the withdrawing
partner by the partnership.
If
a partner ceases to be a partner under local law and receives payments
from the partnership in liquidation of his partnership interest, §736
applies regardless of the reason.80
The regulations under §736 are not concerned with the reasons or the
circumstances surrounding a partner's ceasing to be a member of the
partnership and the courts have concluded that §736 applies whether
the withdrawal is voluntary or involuntary.
In
Holman v. Comr.,81 two partners expelled from a law partnership
received their respective shares of partnership capital according to
the terms of the partnership agreement. The expelled partners
also received an amount based on their share of accounts receivable
for work that had been billed and an amount based on unbilled services.
The expelled partners argued the full amount received by them was capital
gain, asserting that §736 does not apply to an expulsion. The
Tax Court disagreed and held that the amounts received by the taxpayers
attributable to the receivables and unbilled services were described
in §736(b)(2) and therefore taxable as ordinary income.
In
Milliken v. Comr.,82 the taxpayer, expelled from an accounting
firm, argued that §736 did not apply to payments he received from the
partnership because his expulsion was illegal and, consequently, did
not constitute a retirement for purposes of §736. The Tax Court,
however, held that the characterization of the payments was governed
by §736. According to the court, even if the taxpayer's expulsion
was wrongful under state law, it was effective to sever the taxpayer's
status as a partner. Since the expulsion was effective to sever
the taxpayer's membership in the partnership under state law, the court
held that §736 applied whether or not the expulsion was wrongful.
Section
736 may apply to the withdrawal of a partner even where the partner
receives neither cash nor property in connection with the withdrawal.
According to §752, a reduction in a partner's share of partnership
liabilities is treated as a distribution of cash from the partnership
to the partner. Regs. §1.736-1(a)(2) states that a deemed distribution
of cash because of a reduction in a partner's share of partnership debt
in connection with the partner's withdrawal is considered a payment
subject to §736.83 The year of the constructive payment
due to the reduction in liabilities is determined under the rules of
§752. If a partner withdraws from a partnership when the partnership
has liabilities but receives no distribution in connection with the
withdrawal, the partner is nevertheless considered to have received
a payment for purposes of §736 because of the reduction in his share
of partnership indebtedness.
In
Stilwell v. Comr.,84 the taxpayer withdrew from a two-person
partnership and received nothing for his partnership interest.
The other partner agreed to pay all debts of the partnership.
The taxpayer argued that he was entitled to an ordinary loss in connection
with the withdrawal measured by his basis in his partnership interest.
The Tax Court disagreed and held that the loss was capital in nature,
stating that the taxpayer received a deemed distribution of cash pursuant
to §752 due to the relief from partnership indebtedness. The deemed
payment was subject to §736 and, pursuant to §§736(b) and 731, the
loss resulting from the withdrawal was capital in nature. The Tax Court
held that relief of a partner's share of liabilities with no distribution
of either cash or property constitutes a §736 payment.
F.
Federal Income Tax Techniques Involved in the Use of Disregarded Entities
(Single Member LLCs) in Mergers, Acquisitions and Dispositions
Mergers of
Corporate Entities and Disregarded Entities
A
great increase of disregarded entities has raised issues regarding the
ability to treat certain transactions as statutory mergers under
§368(a)(1)(A).85 Final regulations published in 2006
provide guidance on the merger of a disregarded entity into an acquiring
corporation and the merger of a target corporation into a disregarded
entity.
Statutory
merger transactions can involve disregarded entities under these regulations.86
The rules permit a target corporation to merge under state law into
a disregarded entity wholly owned by another corporation. This transaction
is the equivalent of merging a corporate target into a division of an
acquiring corporation. A disregarded entity is not allowed to
merge on a tax-free basis with a corporate acquiror unless the disregarded
entity's owner is also merged into the acquiror. These rules affect
the treatment of disregarded LLCs being merged into acquiring corporations,
and merging target corporations into disregarded LLCs. These rules
only apply to merger transactions under §368(a)(1)(A). A transaction
may be tax-free if it qualifies under other reorganization provisions
such as "C," "D," or "F."
Tax-free
Disposition of a Business Enterprise Interest
Owners of a business enterprise may
wish to dispose of the business enterprise or its assets without generating
an income tax liability. There are many reasons for seeking deferral
of gain recognition for income tax purposes, including:
(1)
Benefiting from the "time value of money."; and,
(2)
The income tax potential on the property appreciation will disappear
if the asset is held at the time of death of an individual owner.
On that event the tax basis of the asset is stepped up to its fair market
value as of that date.87
Sometimes
the income tax provisions allow postponement of income tax recognition
where only the form, not the substance, of the investment has changed.88
In those cases, gain recognition is deferred. In the corporate
situation, this nonrecognition treatment applies in the framework of
certain transfers of assets to controlled corporations and tax-free
corporate "reorganizations."89
In
the sole proprietorship and partnership there are less precise rules
to determine whether gain recognition postponement is possible on a
disposition of an interest in the entity, the entity's business interest,
or investment property. Gain postponement may be accomplished
under the like-kind tax-free exchange provision.90 This result may be achieved between
related entities if the entities are disregarded entities for income
tax purposes.
The "sole proprietorship"
is not a separately identifiable asset that can be transferred for income
tax purposes.91 Each of the assets of the sole proprietorship
is treated as separately transferred. The transfer of each asset
constitutes a gain or loss; realization or non-realization; or recognition
or non-recognition event. The tax character of any gain or loss
from each asset transfer is determined by reference to the tax nature
of each of those assets. The postponement of gain recognition
is generally dependent on the tax characterization of each asset.
There
are two choices available in transferring sole proprietorship assets
without recognition of gain: the like kind exchange provision or a corporate
tax-free acquisitive corporate reorganization provision, which is utilized
after transferring the sole proprietorship assets into a corporation
in a tax-free incorporation transaction.
a. Like-Kind
Exchanges
Some assets
of a sole proprietorship can be exchanged for other like kind assets
without gain recognition being recognized. The assets eligible for
this treatment could include land, buildings, machinery, technology,
patents, trademarks and trade names. Under this provision are
inventory,92 stocks, bonds, or notes,93 other
securities or evidences of indebtedness or interest,94 interests
in a partnership,95 certificates of trust or beneficial interests,96
choses in action,97 and goodwill which are not eligible for
like kind exchange treatment.98 Illiquid assets are
ordinarily eligible for this gain postponement,
Certain
limiting rules do apply for using this gain postponement provision when
the like kind property exchange is between related persons.99
If a person exchanges property with a related person, there is non-recognition
of gain or loss to that exchanging person with respect to the exchange
of such property, and before the date two years after the date of the
last transfer which was part of such exchange then either the related
person disposes of such property, or the exchanging person disposes
of property received in the exchange from the related person which was
of like kind to the property transferred by the transferor, non-recognition
of gain or loss is not permitted to the taxpayer with respect to that
exchange.100 This rule does not apply if the disposition
occurs after the death of the taxpayer or the related person;101
in an involuntary conversion, if the exchange occurred before the threat
or imminence of such conversion;102 or if it is established
that neither the exchange nor the disposition of the asset had as one
of its principal purposes the avoidance of federal income tax.103
Transfer to Controlled Corporation
If
the sole proprietor wishes to transfer the entire proprietorship on
a gain deferral basis, this can be accomplished by transferring the
entity into corporate form in a tax-free incorporation and then exchanging
those shares in a tax-free corporate reorganization. Unless the S corporation
election is available, this incorporation transaction can eventually
cause an additional layer of income tax to be incurred.
Since the tax law definition of "corporation"
(§7701(a)(3)) includes an "association" with corporate characteristics,
the IRS has recognized that non-corporate entities taxable as corporations,
including S corporations, may engage in tax-free reorganizations in
the same manner as formally incorporated entities. These rulings
should apply to a merger or consolidation involving one or more noncorporate
entities as well, as long as the parties to the transaction are taxable
under federal law as corporations.104 The regulations
refer to mergers as occurring between "combining units," which
can consist of an entity taxed as a corporation plus all of the disregarded
entities it is treated as owning. The merger of a corporation
into a disregarded entity in exchange for stock of the disregarded entity's
owner can qualify as a statutory merger or consolidation.105
G.
Taxation on Sales of an Interest - Handling the Holding Periods and
Hot Asset Issues
Character
and Holding Period of Distributed Property
When
property is distributed by a partnership to a partner, its character
is determined under the Code's general principles of characterization.106
A limited set of principles serves to prevent the conversion of ordinary
income into capital gain. First, unrealized receivables distributed
to a partner are permanently classified as ordinary assets, and any
gain or loss recognized from their disposition is treated as ordinary
gain or loss.107 Second, inventory items distributed
to a partner are subject to mandatory classification as ordinary assets
for the first five years after distribution. If a partner disposes
of the inventory during the five-year period following the distribution,
any gain or loss must be classified as ordinary gain or loss.108
After that five-year period, the gain is classified according to the
general characterization rules. A partner's holding period for distributed
property includes the partnership's holding period for that property.109
Disproportionate
Distributions
The
"hot asset" rules limit the taxpayers' ability to route capital
gain and ordinary income selectively among the partners.110
The term "hot assets" refers to unrealized receivables, and
substantially appreciated inventory items.111 Inventory
is "substantially appreciated" if its fair market value is
at least 120% of its basis.112
The
?hot asset? rules apply to any disproportionate distribution of
property that alters a partner's share in the partnership's ?hot assets?.
This can be accomplished by a disproportionate distribution of the ?hot
assets? themselves or a disproportionate distribution of other assets.
The partner is treated as though he has received a proportional share
of each partnership asset, to which the basic distribution rules apply,
and then engaged in a taxable exchange with the partnership in which
he exchanged a fractional interest in the assets received for a fractional
interest in the assets the partnership retained.113
This is accomplished in a four-step process:114
1.
Identification of the assets for which the hypothetical exchange occurs;
2. A deemed
distribution to the partner of the assets in which the partner's proportionate
share is reduced, but only to the extent of the reduced share of those
assets;
3. A deemed
taxable exchange in which the partner is deemed to transfer back the
assets deemed received in exchange for assets in which the partner's
interest is increased, this is only to the extent of the increased share
of those assets; and
4. The
distribution of the partner's pro-rata share of the partnership's assets
which is treated as an ordinary distribution.
These
?hot asset? rules apply whether the distribution is a liquidation
of the distributee partner's complete interest but only to the extent
that he either receives ?hot assets? in exchange for his interest
in other property, or he receives other property in exchange for his
interest in the ?hot assets?115
I.
Dispositions of Partnership Interests
The
general rule is that the sale or exchange of a partnership interest
is treated as the taxable sale of a single asset.116 The normal rule is the gain is the
excess of the amount realized over the selling partner's outside basis.117
The partnership interest is classified as a capital asset, which makes
the gain or loss recognized as capital gain or loss.118
This
is then modified in two respects. First, a portion of the sales
price is allocated to the selling partner's share of the partnership's
unrealized receivables and inventory, converting a portion of the capital
gain or loss into ordinary income or loss. Second, an adjustment
of the partnership's inside basis in its assets to reflect the gain
or loss recognized by the disposition of the partnership interest.
Ordinary
Income for "Hot Assets"
A
portion of the sales price for a partnership interest reflects the value
of the selling partner's share in the partnership's unrealized receivables
and inventory. If the partnership recognizes income with respect to
these items, it is ordinary income, a portion of which is allocated
to the selling partner. The §751 "hot asset" rule ensures
that a partner who accesses this value by selling his partnership interest
does not convert ordinary income into capital gain.119
This
is very much like the ?hot asset? rule that applies to disproportionate
distributions of property, but with two significant differences.
First, in the disproportionate distribution the rule applies only to
inventory items that have substantially appreciated in value, but in
the sale of partnership interests, the rule applies to all inventory
items.120 Unrealized receivables are subject to the
?hot asset? rule in both cases.121
Second,
the application of the ?hot asset? rule is simpler in the disposition
of a partnership interest. Its implementation requires a four-step
procedure:122
1. The
partner calculates gain or loss as though the sale of the partnership
interest were the sale of a single asset;
2. The
partner calculates the amount of gain or loss the partnership would
recognize if it disposed of all of its unrealized receivables and inventory
at their fair market values;
3. The
partner determines how much of the hypothetical gain or loss calculated
in Step 2 would be allocated to the partner, and treats that amount
as ordinary income or loss; and
4. The
partner subtracts the amount determined in Step 3 from the amount determined
in Step 1. That amount is the capital gain or loss from the sale
of the partnership interest.
It
is possible to generate ordinary income in a transaction that generates
an overall loss, which would make the capital loss amount greater than
the overall loss.
The ?hot
assets? may generate an ordinary loss in a transaction that generates
an overall gain, thereby making the capital gain amount greater than
the overall gain.
H.
Using Elections to Make Optional Basis Adjustments to Minimize Tax in
Distributions
A partnership distribution of cash
or property to a partner will generally have no effect on the partnership
or on the remaining partners unless there is a §754 election or a "substantial
basis reduction." This general rule states that the basis
of partnership property is not adjusted as a result of a distribution
by the partnership to a partner.
If
a §754 election is in effect when the partnership distributes property,
the partnership usually makes an offsetting basis adjustment to remaining
partnership assets under §734(b). This adjustment is made if
the partner recognizes a gain or loss or gets a different basis in the
property than the predistribution basis. When this occurs, the
partner will either recognizes a gain or take a basis in the property
that is less than the partnership's predistribution basis. The
partnership will increase its basis in their retained assets by the
same amount. If the partner recognizes a loss on the liquidation
of his interest or takes a greater basis in the property than the partnership
had, the partnership is required to decrease its basis in their retained
assets. This is required if there is a §754 election or a "substantial
basis reduction".
A
partnership must adjust its basis in the their retained assets if there
is a "substantial basis reduction" in reference to the distribution.
A "substantial basis reduction" occurs when the amount of
loss recognized by the partner in a distribution in liquidation of his
interest plus the excess of the basis of property distributed to him
over the partnership's adjusted basis in the property immediately before
the distribution, totaled exceeds $250,000. A substantial basis
reduction is deemed to have occurred when a partnership is required
to make a downward adjustment of more than $250,000 because of the §754
election. This downward adjustment must also be made regardless
of whether there is a §754 election.
The
procedure for making the §734 basis adjustment is the same, whether
the partnership must make the adjustment because a §754 election or
because there is a substantial basis reduction.
Once
a §754 election is made, it will apply to all subsequent distributions.
It may be revoked with consent of the IRS.123 The election
is made by filing a written statement with the partnership's tax return
for the first year the election is to apply.124
§734(b)
If a §754 election applies to a partnership
distribution of property and the partner takes a basis in the property
that is different from the partnership's predistribution basis, or there
is a substantial basis reduction with respect to a partnership distribution,
then §734(b) and §734(b) will be used to calculate the amount the
partnership must use to adjust the basis in its remaining assets.
This
adjustment calculation of the partnership's basis in its assets under
§734 involves two steps: (1) the amount of the total adjustment needs
to be determined under §734(b); and (2) then that total adjustment
must be allocated among the partnership's assets.125
If a partner recognizes either gain
or loss in connection with a partnership distribution, the measure of
the §734(b) adjustment is equal to the amount of gain or loss recognized
by the partner.126 Gain recognition by the partner results
in a positive adjustment to the partnership's basis in undistributed
property equal to the amount of the gain recognized.127 If
a partner recognizes a loss on the distribution, the §734(b) adjustment
is a negative adjustment equal to the distributee's recognized loss.128
Another situation that requires a
§734(b) adjustment occurs when a partner's basis in property distributed
to him is greater or less than the partnership's basis in the property
immediately before the distribution.129 The partner?s
basis in the property is not the same as the partnership's pre-distribution
basis in two circumstances. The first circumstance is in the case
of a current distribution. A partner's basis in distributed property
may not exceed his basis in his partnership interest.130
If the partner's basis in distributed property is less than the partnership's
predistribution basis in that property due to this limitation, a positive
§734(b) adjustment may be made equal to that difference. Therefore,
the partnership is entitled to increase the basis of its remaining assets.131
The
second circumstance is when a partner's basis in property is not the
same as the partnership's pre-distribution basis in the property.
This occurs with a liquidating distribution. When the partner?s
interest is liquidated, the partner's basis in the property will equal
the adjusted basis he had in his partnership interest, less any money
distributed to him in the liquidating distribution.132If
this causes the partner's basis in distributed assets being less than
the partnership's predistribution basis, the partnership may increase
the basis of its remaining property the amount of the difference.133
Also, if the partner receives a greater basis in the property than the
partnership had, the partnership must reduce the basis of its remaining
assets by an amount equal to that excess.134
Allocations
Between Asset Classes
A partnership property distribution resulting in an adjustment to the
basis of undistributed partnership property requires the partnership
to allocate the adjustment to the remaining partnership property.
This allocation must be of a character similar to that of the distributed
property.135 When the partnership's adjusted basis
of distributed capital gain property immediately before the distribution
exceeds the basis of the property to the partner, the partnership must
increase the basis of the undistributed capital gain property by an
equal amount.136 When the partnership's adjusted basis
of distributed capital gain property immediately before the distribution
is less than the basis of the property to the distributee partner, the
partnership must decrease the basis of the undistributed capital gain
property by an equal amount.137 When a partnership
distributes ordinary income property and the partner's basis is not
the same as the partnership's basis in the property immediately before
the distribution, the partnership must make the §734(b) adjustment
only to undistributed property of the same class remaining in the partnership.
When a partnership must adjust its undistributed property because the
distributee partner recognized gain or loss, the partnership must allocate
the adjustment entirely to capital gain property.138 The
total §734(b) basis adjustment must be allocated first to the following
classes of partnership property: (1) capital gain assets, including
§1231(b) property; and (2) ordinary income assets.139A
partner may not recognize gain or loss immediately if he receives payments
over time in complete liquidation of his interest in a partnership.
The partner only recognizes gain to the extent the total amount of money
distributed exceeds his adjusted basis in the partnership interest immediately
before the distribution.140 The partner will only recognize
a loss when he receives the final payment in a series of distributions
in liquidation of his interest.141 The partner may elect
to report a pro rata portion of each payment as gain or loss if the
total amount of payments that the partner will receive over time is
fixed.142
References
1Regs. §§ 301.7701-2(b)
2Regs. § 301.7701-1(a)(1);
Regs. §301.7701-1(a)(3).
3Regs. §301.7701-2(a).
4Regs. §301.7701-2(c)(2)
5
Rev. Proc. 2002-69, 2002-45 I.R.B. 831.
6
Regs. §301.7701-2(c)(1).
7Regs. §301.7701-2(b).
8Regs. §301.7701-2(b)(3).
9Regs. §301.7701-2(b)(4).
10Regs. §301.7701-2(b)(5).
11Regs. §301.7701-3(a).
12Regs. §301.7701-3(a).
13Regs. §301.7701-3(b)(1).
14Regs. §301.7701-3(c)(1)(i).
15Regs. §301.7701-3(c)(1)(i).
16Regs. §301.7701-3T(c)(1)(ii)
17Regs. §301.7701-3T(c)(1)(ii).
18Regs. §301.7701-3(c)(2)(i).
19Regs. §301.6109-1(h)(1),
20Regs. §301.6109-1(h)(2)(i).
21Regs. §301.7701-3(c)(1)(iii).
22gs. §301.7701-3(c)(1)(iv).
23Regs. §301.7701-3(g)(1)(i)
24Regs. §301.7701-3(g)(1)(iv).
25Regs. §301.7701-3(g)(1)(ii).
26Regs. §301.7701-3(g)(1)(iii).
271999-6 I.R.B.
6.
28§707(c).
29§61.
30§707(c). See
§§263, 263A.
31410 U.S. 441 (1973).
32§733.
33§731.
34See §751(b).
35§§732, 733.
36§731(a)(2).
37§731(a)(1).
38§732(a).
39§733.
40§ 404(a)(8).
41§ 416(g)(1)(A).
42§ 416(i).
43§ 1402(a)(13).
44§1402(a)(13).
45Prop. Regs.
§1.1402(a)-2(h).
46Preamble to REG-209824-96,
62 Fed. Reg. 1702 (1/13/97).
47Prop. Regs.
§1.1402(a)-2(g).
48Prop. Regs.
§1.1402(a)-2(h)(2).
49Prop. Regs.
§1.1402(a)-2(h)(5).
50Prop. Regs.
§1.1402(a)-2(h)(3).
51P.L. 105-34, §935.
5260 T.C.M. 603
(1990).
5360
T.C.M. 603 (1990).
5467 T.C.M. 2966 (1994).
5567
T.C.M. 2966 (1994).
5679
T.C.M. 1642 (2000).
57Id.
58Regs. §301.7701-3(g)(1)(iv)
59Regs. §301.7701-3(g)(1)(ii).
60Regs. §301.7701-3(g)(1)(iii).
61§
721(a).
62 § 722.
63§ 721(a).
64PLR 9636007
65 PLRs 9701029,
9543017, 9409014, and 9404021.
66Rev. Rul. 84-52.
67Regs. §1.708-1(b)(2).
68 1995-1 C.B. 130.
69§736(b)(1).
70§736(b)(3).
71§736(b)(2).
72Regs. §1.761-1(d).
73Regs. §1.736-1(a)(1)(i).
74Regs. §1.736-1(a)(1)(ii).
75Id.
76Regs. §1.761-1(d)
77Regs. §1.736-1(a)(1)(i).
78Id.
79Regs. Sections
1.736-1(a)(6) and 1.708-1(b)(1)(i)(b).
80Regs. §1.736-1(a)(1)(ii).
8166 T.C. 809 (1976),
aff'd, 564 F.2d 283 (9th Cir.1977).
8272 T.C. 256 (1979),
aff'd in unpub. opin. (1st Cir. 1979).
83Regs. §1.736-1(a)(2)
8446 T.C. 247 (1966).
85T.D. 9242, 71
Fed. Reg. 4259 (1/26/06).
86Regs. §1.368-2(b)(1),
T.D. 9242, 71 Fed. Reg. 4259 (1/26/06).
87Section 1014(a)
88§1031.
89§§354(a)1),
368(a)(1).
90§ 1031.
91Williams v.
McGowan, 152 F.2d 570 (2d Cir. 1945).
92§ 1031(a)(2)(A).
93§ 1031(a)(2)(B).
94§ 1031(a)(2)(C).
95§ 1031(a)(2)(D).
96§ 1031(a)(2)(E).
97§ 1031(a)(2)(F).
98Regs. § 1.1031(a)-2(c)(2).
99Section 1031(f)(3)
100§ 1031(f)(1)
101§ 1031(f)(2)(A).
102§ 1031(f)(2)(B)
103§ 1031(f)(2)(C).
104Regs. §1.368-2(b)(1)(i)(B)
(T.D. 9242, 71 Fed. Reg. 4259 (1/26/06))
105Regs. §1.368-2(b)(1)(iii)
Ex. 2, T.D. 9242, 71 Fed. Reg. 4259 (1/26/06).
106§1221.
107§735(a)(1).
108§735(a)(2).
109§735(b).
110§751.
111§751(b)(1).
112§751(b)(3)(A).
113§751(b)(1).
114Regs. §1.751-1(b).
115Regs. §1.751-1(b)(1)(i).
116§741.
117§1001.
118§741.
119§751(a).
120 §751(b)(1)(A)(ii
121§751(a)(1),
(b)(1)(A)(i).
122Regs. §1.751-1(a).
123Regs. §1.754-1(a).
124Regs. §1.754-1(b).
125§734(c).
126§§ 734(b)(1)(A),
734(b)(2)(A).
127§ 734(b)(1)(A).
128 §734(b)(2)(A).
129§§734(b)(1)(B),
734(b)(2)(B).
130§732(a)(2).
131§734(b)(1)(B).
132
§732(b)
133
§734(b)(1)(B).
134§734(b)(2).
135§ 755(b) and
Regs. §1.755-1(c)(1)(i).
136§ 734(b)(1)
and Regs. §1.755-1(c)(1)(i)
137
§ 734(b)(2) and Regs.
§1.755-1(c)(1)(i)
138.Regs. §1.755-1(c)(1)(ii).
139
Regs. §1.755-1(a).
140Regs. §1.731-1(a)(1)(i).
141 Regs. §1.731-1(a)(2).
142 Regs. §1.736-1(b)(6).
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