Archive for the ‘Partnerships’ Category

The Basics of SMLLCs

January 6, 2014

By Joanna Nguyen

Single member limited liability companies (SMLLCs), like all LLCs, are designed to protect against personal liability.  An SMLLC is treated as a “disregarded entity” for federal income tax purposes, unless it formally elects to be treated as a corporation.  Thus, its earnings and losses will be reported on an individual member’s personal return on Schedule C as if it were a sole proprietorship.  In other words, an SMLLC will be considered a sole proprietorship for federal tax purposes, but will not lose other benefits associated with being a corporate entity.  Therefore, the SMLLC does not need to file any tax forms for federal purposes.

In most states, an SMLLC is treated as a “disregarded entity” for tax purposes.  For California income tax purposes, payment of the annual tax and LLC fee is required and therefore, a California SMLLC should file Form 568 with Page 1, Page 2, and the LLC Income Worksheet.  The LLC fee is applicable if total California annual income (gross receipts and not net income) is $250,000 or greater.  The fee ranges from $900 to $11,790.

Although an SMLLC protects against personal liability, it will not protect against a claim based on negligence, professional malpractice, or other personal wrongdoing that the owner commits related to the business.  Therefore, if a sole proprietor is able to acquire liability insurance, other types of business formations can be considered.

For more information about SMLLCs, please contact our office at (714) 836-8300.

Out of State Taxpayer Sues California FTB on LLC Doing Business Issue

July 22, 2013

Via Spidell Publishing

An out-of-state corporate taxpayer has filed suit against the California Franchise Tax Board (FTB) to recover taxes, penalties, and interest assessed by the FTB for being a passive member in a California LLC. (Swart Enterprises Inc. v. Franchise Tax Board, filed July 9, 2013, Case No. 13CECG02171)

This case makes public the FTB’s position that a taxpayer’s passive interest in a California LLC is sufficient to determine that the taxpayer is “doing business in California”, and trigger the minimum franchise tax under R&TC §23153.

In Swart, the corporation’s principal place of business is in Iowa. The corporation did no business in California but owned a 0.02% interest in a California LLC that acquired, held, leased, and disposed of capital equipment and interest in capital equipment in various states.

This case will be of great interest to our clients with out-of-state investors and with out-of-state investments.  Especially real estate development and investment partnerships.  We will continue to monitor this case.

Newly Proposed IRS Regulations Intend to Clarify Definition of Limited Partner for Purposes of Material Participation

January 9, 2013

A question that often comes up in the course of our work is whether a taxpayer is materially participating in a trade or business.  Material participation is an important concept because the tax treatment of income or losses from a trade or business will be classified as passive or non-passive accordingly.  If a taxpayer does not materially participate in a trade or business, the activity is treated as passive.  Additionally, by statutory definition, all rental activities, even those in which the taxpayer materially participates, are generally treated as passive activities.  Material participation is defined as involvement in the operations of the activity that is regular, continuous and substantial, per IRC §416(h)(1).  There are seven tests that determine whether someone should be treated as materially participating.  In order to be considered materially participating, a taxpayer would need to meet one of these seven tests.

Limited partners are generally treated as not materially participating in partnership activities and therefore flow-through income and losses are treated as passive. Currently, a partnership interest is considered to be a limited partnership interest if the partnership agreement indicates it is limited or if the liability of the partner is limited for obligations of the partnership according to the  state laws in the state in which the partnership is formed.

The seven material participation tests are:

  1. Individual participates in the activity for more than 500 hours during the year
  2. Individual’s participation in the activity for the year constitutes substantially all of the participation of all individuals involved in the activity for the year
  3. Individual participates in the activity for more than 100 hours during the year, and such participation is not less than anyone else’s participation, including non-owners
  4. Activity is a significant participation activity (more than 100 hours), and the individual’s aggregate participation in all significant activities exceeds 500 hours
  5. Individual materially participates in the activity for any 5 out of the previous 10 taxable years preceding the taxable year
  6. Activity is a personal service activity (health, law, engineering, accounting, etc.) and individual materially participated in the activity for any 3 taxable years preceding the taxable year
  7. Based on all of the facts and circumstances, the individual participates in the activity on a regular, continuous and substantial basis during the year

The IRS has issued proposed regulations to modify the definition of a “limited partner” as it relates to a taxpayer being treated as materially participating.  If the holder of the interest in a partnership does not have management rights during the entire tax year, the proposed regulations detail that an interest in the entity would be treated as a limited partnership interest.  One exception to the rule is if an individual has both a limited and a general partner interest.  In this case, they would be treated as a general partner. Under the proposed regulations, it will become easier for individuals to meet the material participation tests. Fewer partnership interests will be treated as limited interests for passive loss purposes and as a result, taxpayers will be able to report the income or losses as non-passive.

2012 Year-End Tax Planning

November 12, 2012

Year-end tax planning is always complicated by the uncertainty that the following year may bring and 2012 is no exception. Indeed, 2012 is one of the most challenging in recent memory for year-end tax planning. A combination of events – including possible expiration of some or all of the “Bush-era” tax cuts after 2012, the imposition of new so-called Medicare taxes on investment and wages, doubts about renewal of tax extenders, and the threat of massive across-the-board federal spending cuts – have many taxpayers asking how can they prepare for 2013 and beyond, and what to do before then. The short answer is to quickly become familiar with expiring tax incentives and what may replace them after 2012 and to plan accordingly.

INDIVIDUAL TAX PLANNING

“Bush-era” Tax Cuts – The phrase “Bush-era” tax cuts is the collective term for the tax measures enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). EGTRRA and JGTRRA made over 30 major changes to the Tax Code that are scheduled to sunset at the end of 2012.

The 2010 Tax Relief Act extended the reduced individual income tax rates from the Bush-era tax cuts. Unless extended further, the reduced individual income tax rates will disappear after 2012 to be replaced by higher rates. The current 10, 15, 25, 28, 33 and 35 percent rate structure would be replaced by the higher pre-Bush 15, 28, 31, 36 and 39.6 percent rates.

Strategy: Traditional year-end planning techniques should be considered along with some variations on those strategies. Instead of shifting income into a future year, taxpayers may want to recognize income in 2012, when lower tax rates are available, rather than shift income to 2013. Another valuable year-end strategy is to "run the numbers" for regular tax liability and alternative minimum tax (AMT) liability. Taxpayers may want to explore whether certain deductions should be more evenly divided between 2012 and 2013, and which deductions may qualify, or will not be as valuable, for AMT purposes.

Qualified Capital Gains – Unless Congress takes action, the tax rates on qualified capital gains are also scheduled to increase significantly after 2012. The current favorable rates of zero percent for taxpayers in the 10 and 15 percent brackets and 15 percent for all other taxpayers will be replaced by pre-2003 rates of 10 percent for taxpayers in the 15 percent bracket and a maximum 20 percent rate for all others.

Strategy: Now is also a good time to consider tax loss harvesting strategies to offset current gains or to accumulate losses to offset future gains (which may be taxed at a higher rate). The first consideration is to identify whether an investment qualifies for either a short-term or long-term capital gains status, because one must first balance short-term gains with short-term losses and long-term gains with long-term losses. Remember also that the "wash sale rule" generally prohibits one from claiming a tax-deductible loss on a security if one repurchases the same or a substantially identical asset within 30 days of the sale.

Dividends – Under current law, tax-favorable dividends’ tax rates are scheduled to expire after 2012. Qualified dividends are currently eligible for a maximum 15 percent tax rate for taxpayers in the 25 percent and higher brackets and zero percent for taxpayers in the 10 and 15 percent brackets.

If Congress takes no action, qualified dividends will be taxed at the ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent not taking into account the 3.8 percent Medicare contribution tax for higher income individuals).

Strategy: Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013.

3.8 Percent Medicare Contribution Tax – Taking effect immediately on January 1, 2013, the Medicare surtax will be imposed on a taxpayer’s “net investment income” (NII) and will generally apply to passive income. The Medicare surtax will also apply to capital gains from the disposition of property. However, the Medicare surtax will not apply to income derived from a trade or business, or from the sale of property used in a trade or business. For individuals, the Medicare surtax is based on the lesser of the taxpayer’s NII or the amount of “modified” adjusted gross income (MAGI) above a specified threshold.

The MAGI thresholds are:

  • $250,000 for married taxpayers filing jointly
  • $200,000 for single

NII includes:

  • Gross income from interest, dividends, annuities, royalties and rents, provided this income is not derived in the ordinary course of an active trade or business;
  • Gross income from a trade or business that is a passive activity;
  • Gross income from a trade or business of trading in financial instruments or commodities; and
  • Net gain from the disposition of property, other than property held in an active trade or business.

NII does not exclude:

  • Distributions from qualified retirement plans or IRAs
  • Veterans’ benefits
  • Gain excluded on sale of principal residence
  • Interest on tax exempt bonds

Strategies:

  • Do not postpone the first year IRA distribution to 2013 on reaching age 70.5.
  • Trust returns are also subject to the Medicare Contribution Tax.  Trust income will often reach the highest tax brackets much quicker than individuals.  Make sure that all income has been distributed from the trust before year end.

Additional 0.9 Percent Medicare Tax – Also effective January 1, 2013, higher income individuals will be subject to an additional 0.9 percent HI (Medicare) tax. This additional Medicare tax should not be confused with the 3.8 percent Medicare surtax. The additional Medicare tax means that the portion of wages received in connection with employment in excess of $200,000 ($250,000 for married couples filing jointly) will be subject to a 2.35 percent Medicare tax rate. The additional Medicare tax is also applicable for the self-employed.

Strategy: Taxpayers may want to explore the possibility of accelerating income into 2012.

End of Payroll Tax Holiday – For the past two years, an employee’s share of Old Age, Survivors and Disability Insurance (OASDI) taxes has been reduced from 6.2 percent to 4.2 percent (with comparable relief for the self-employed). Under current law, that reduction is scheduled to expire after December 31, 2012. On January 1, 2013, an employee’s share of OASDI taxes will revert to 6.2 percent, effectively increasing payroll taxes across the board.

Strategy: Taxpayers may want to explore the possibility of accelerating bonuses and wages into 2012.

Alternative Minimum Tax – The alternative minimum tax rates (26 and 28 percent on the excess of alternative minimum taxable income over the applicable exemption amount) are not scheduled to change in 2013. However, exposure to the AMT may change as a result of the scheduled sunset of the regular tax rates. Because the determination of AMT liability requires a comparison between regular tax and AMT computations, the higher regular tax rates post-2012 may help lower AMT exposure by the same amount.

However, taxpayers should not ignore the possibility of being subject to the AMT, as this may negate certain year-end tax strategies. For example, if income and deductions are manipulated to reduce regular tax liability, AMT for 2012 may increase because of differences in the income and deductions allowed for AMT purposes.

As in past years, taxpayers are waiting to see if Congress will enact an AMT “patch” for 2012. The last patch, which provided for increased exemption amounts and use of the nonrefundable personal credits against AMT liability, expired after 2011.  If another “patch” is not enacted by Congress, the AMT exemption will drop from $74,450 (married taxpayers filing jointly) in 2011 to $45,000 in 2012.

Personal Exemption/Itemized Deduction Phaseouts – Higher income taxpayers may also be subject to the return of the personal exemption phaseout and the so-called Pease limitation on itemized deductions. Both of these provisions were repealed through 2012. However, they are scheduled to return after 2012 unless the repeal is extended.

Revival of the personal exemption phaseout rules would reduce or eliminate the deduction for personal exemptions for higher income taxpayers starting at “phaseout” amounts that, adjusted for inflation, would start at $267,200 AGI for joint filers and $178,150 for single filers.

In addition, return of the Pease limitation on itemized deductions (named for the member of Congress who sponsored the legislation) would reduce itemized deductions by the lesser of:

  • Three percent of the amount of the taxpayer’s AGI in excess of a threshold inflation-adjusted amount projected for 2013 to be $178,150 (joint filers), or
  • 80 percent of the itemized deductions otherwise allowable for the tax year.

Strategy: Taxpayers should watch AGI limitations when determining deductions and credits to report in 2012/2013.  Taxpayers should consider paying deductible items in 2013 when tax rates are higher and could result in a more advantageous tax benefit.

Education – American Opportunity Tax Credit. In 2009, Congress enhanced the Hope education credit and renamed it the American Opportunity Tax Credit (AOTC). The temporary enhancements, including a maximum credit of $2,500, availability of the credit for the first four years of post-secondary education, and partial refundability for qualified taxpayers, are scheduled to expire after 2012. Under current law, less generous amounts will be available with the revived Hope education credit.

Coverdell Education Savings Accounts. Similar to IRAs, Coverdell Education Savings Accounts (Coverdell ESAs) are accounts established to pay for qualified education expenses. Under current law, the maximum annual contribution to a Coverdell ESA is $2,000, and qualified education expenses include elementary and secondary school expenses. Unless extended, the maximum annual contribution for a Coverdell ESA is scheduled to decrease to $500 after 2012.

Employer-Provided Education Assistance. Under current law, qualified employer-provided education assistance of up to $5,250 may be excluded from income and employment taxes. However, the 2010 Tax Relief Act only made the exclusion available through 2012.

Student Loan Interest. Individual taxpayers with MAGI below $75,000 ($150,000 for married couples filing a joint return) may be eligible to deduct interest paid on qualified education loans up to a maximum deduction of $2,500, subject to income phaseout rules. The enhanced treatment for the student loan interest deduction is scheduled to expire after 2012.  The student loan interest deduction would be limited to the first 60 months of payment.

Higher Education Tuition Deduction. The above-the-line higher education tuition deduction expired after 2011. The maximum $4,000 deduction was available for qualified tuition and fees at post-secondary institutions, subject to income phaseouts.

Child Tax Credit – Taxpayers who claim the child tax credit need to plan for its scheduled reduction after 2012. Absent Congressional action, the child tax credit, at $1,000 per eligible child for 2012, will be $500 per eligible child, effective January 1, 2013.

Sales Tax Deduction – Before 2012, qualified taxpayers could deduct state and local general sales taxes in lieu of deducting state and local income taxes. The 2010 Tax Relief Act last extended the optional itemized deduction for state and local general sales taxes, which had been available since 2004, to tax years 2010 and 2011. Unless extended again, the deduction for state and local general sales taxes will not be available for tax year 2012 and beyond.

Qualified Mortgage Insurance Premiums – For the period 2007 through 2011, premiums paid for qualified mortgage insurance could be treated as qualified residence interest and deducted as an itemized deduction, subject to certain restrictions. Renewal of this tax break into 2012 is uncertain at this time.

ESTATE/GIFT TAX PLANNING

There have been few areas of the Tax Code that have been subject to as much uncertainty as the federal estate tax.   In 2001, Congress passed legislation that repealed the estate tax in the calendar year 2010.  Under the 2010 Tax Relief Act, federal estate taxes applied to decedents dying after December 31, 2009 but before January 1, 2013.  Through 2012, each individual taxpayer can gift up to $5.12 million out of their estate without paying gift taxes.  Any gifts over the exemption amount are subject to a maximum tax rate of 35%.  Starting in 2013, the estate/gift tax exemption amount is reduced to $1 million and the maximum tax rate jumps up to 55%.

Strategy:  A comprehensive estate plan should be implemented to take advantage of this opportunity to transfer $5 million out of an individual’s estate.  This transfer could ultimately save over $2 million in estate taxes.  Individuals should consider transferring real estate or investments to their beneficiaries now to avoid the estate taxes later.

BUSINESS TAX PLANNING

Code Sec. 179 expensing – Code Sec. 179 gives businesses the option of claiming a deduction for the cost of qualified property all in its first year of use rather than claiming depreciation over a period of years. For 2010 and 2011, the Code Sec. 179 dollar limitation was $500,000 with a $2 million investment ceiling. The dollar limitation for 2012 is $139,000 with a $560,000 investment ceiling. Under current law, the Code Sec. 179 dollar limit is scheduled to drop to $25,000 for 2013 with a $200,000 investment ceiling.

Strategy: Businesses should consider accelerating purchases into 2012 to take advantage of the still generous Code Sec. 179 expensing. Qualified property must be tangible personal property, which one actively uses in one’s business, and for which a depreciation deduction would be allowed.  The amount that can be expensed depends upon the date the qualified property is placed in service; not when the qualified property is purchased or paid for.  Additionally, Code Sec. 179 expensing is allowed for off-the-shelf computer software placed in service in tax years beginning before 2013.

Bonus depreciation – The first-year 50 percent bonus depreciation deduction is scheduled to expire after 2012 (2013 in the case of certain longer-production period property and certain transportation property). Unlike the Section 179 expense deduction, the bonus depreciation deduction is not limited to smaller companies or capped at a certain dollar level. To be eligible for bonus depreciation, qualified property must be depreciable under Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. The property must be new and placed in service before January 1, 2013 (January 1, 2014 for certain longer-production period property and certain transportation property).

Businesses also need to keep in mind the relationship of bonus depreciation and the vehicle depreciation dollar limits.  Code Sec. 280F(a) imposes dollar limitations on the depreciation deduction for the year a taxpayer places a passenger automobile in service within a business, and for each succeeding year. Sport utility vehicles and pickup trucks with a gross vehicle weight rating in excess of 6,000 pounds are exempt from the luxury vehicle depreciation caps.

Expiring business tax incentives – Many temporary business tax incentives expired at the end of 2011. In past years, Congress has routinely extended these incentives, often retroactively, but this year may be different. Confronted with the federal budget deficit and across-the-board spending cuts scheduled to take effect in 2013, lawmakers allow some of the business tax extenders to expire permanently. Certain extenders, however, have bipartisan support, and are likely to be extended.  They include the Code Sec. 41 research tax credit, the Work Opportunity Tax Credit (WOTC), and 15-year recovery period for leasehold, restaurant and retail improvement property.

Small employer health insurance credit – A potentially valuable tax incentive has often been overlooked by small businesses, according to reports. Employers with 10 or fewer full-time employees paying average annual wages of not more than $25,000 may be eligible for a maximum tax credit of 35 percent on health insurance premiums paid for tax years beginning in 2010 through 2013. Tax-exempt employers may be eligible for a maximum tax credit of 25 percent for tax years beginning in 2010 through 2013.

The credit is scheduled to climb to 50 percent of qualified premium costs paid by for-profit employers (35 percent for tax-exempt employers) for tax years beginning in 2014 and 2015. However, an employer may claim the tax credit after 2013 only if it offers one or more qualified health plans through a state insurance exchange.

Today’s uncertainty makes doing nothing or adopting a “wait and see” attitude very tempting. Instead, multi-year tax planning, which takes into account a variety of possible scenarios and outcomes, should be built into one’s approach.

Please contact our office for more details on developing a tax strategy in uncertain times that includes consideration of certain tax-advantaged steps that may be taken before year-end 2012.

Deductibility of Unreimbursed Partnership or S-Corporation Expenses

November 12, 2012

In a partnership, profits and losses generally pass through to their partners.  Typically, the majority of expenses are paid for by the partnership itself.  What happens, though, when a partner personally incurs a partnership expense that is not reimbursed by the partnership?

Generally, a partner may not deduct expenses related to the partnership on his or her individual income tax return.  However, an exception applies when there is an agreement among partners that requires a partner use his or her own funds to pay a partnership expense.  This agreement allows the expenses paid for by the partner to be fully deductible without limitation on their individual income tax return, on Form 1040, Schedule E.  For partners of professional service organizations, deducting a qualifying unreimbursed expense may serve not only to reduce federal and state income taxes, but also to reduce income subject to self-employment tax.

In order to allow your partners to be able to deduct their unreimbursed expenses, we recommend that you review your partnership agreement for a provision described above, requiring partners to use their personal funds to pay partnership expenses.  If such a provision does not exist in your partnership agreement, a simple amendment may be worthwhile to “audit protect” your partners that may be deducting unreimbursed expenses.

Adequate records of all unreimbursed expenses must be maintained in order to claim a deduction.  The following information should be maintained with the documentation for each expense:

  • Date of the expense
  • Place where the expense was incurred
  • The business purpose of the expenditure
  • The amount of the expense

In contrast, there are no similar rules allowing for the deduction of unreimbursed shareholder expenses for organizations operating as S-Corporations.  An S-Corporation’s expenses are solely deductible at the corporate level.  Therefore, unreimbursed expenses incurred by S-Corporation shareholders are not deductible.

IRS Proposes Clarification of Section 83 Rules

June 4, 2012

The Internal Revenue Service recently proposed new rules that would affect when employees have to recognize income on transfers of stock that are treated as compensation under Section 83 of the Internal Revenue Code. The proposed regulations would clarify when a substantial risk of forfeiture exists, postponing the employee’s recognition of income.

Via JournalofAccountancy.com.

Carried Interests (Promote Interests) Under Attack, Again

February 25, 2012

Over the past many years, we have been monitoring legislative initiatives aimed at taxing Carried Interests at ordinary tax rates, and once again, Washington is ramping up its efforts.  On February 14th, Representative Sander Levin outlined a new proposal to increase the tax rate on income earned from Carried Interests.  Additionally, as we discussed in our previous Nienow & Tierney, LLP News blog post here, President Obama’s 2013 Budget Proposal includes the same change.  The President also forwarded the same general proposal in September of last year, as we detailed here.

Carried interests can loosely be defined as interests in partnerships and funds held by the investment organizer based on their efforts to put the venture together. These arrangements are often referred to as “promote interests” as well.  The Internal Revenue Code contains provisions that tax “carried interests” at the more favorable capital gain tax rates. 

In an effort to target large investment funds that utilize this provision, tax proposals, including these latest ones, aim to treat the income from the eventual success of the venture as compensation for services, taxed at ordinary tax rates.  The result is a potential tax rate increase of approximately 30% on such income.

It is estimated that the change would generate $13.5 billion in additional taxes over the next decade.  Levin, who is the top Democrat on the Ways and Means Committee recently stated “this loophole for years has unfairly enabled some of the highest-paid individuals in the country to sharply reduce their tax bills and it is time to close it once and for all”.  In the past, there has been no distinction between the multi-billion investment funds of Wall Street, and the friends and family real estate investment partnership of Main Street.

House Republicans have objected to the potential change saying it would hurt economic growth.

Because this change would impact our clients, we will continue to monitor these legislative developments, and will post updates on the Nienow & Tierney, LLP News blog.

IRS Allows Partnerships to Provide K-1’s Electronically

February 17, 2012

The Internal Revenue Service has issued new rules that will allow partnerships to provide Schedule K-1 electronically, if the recipient consents to receive it electronically. The detailed rules are contained in a new revenue procedure and are effective February 13, 2012.

The new rules are of course, very detailed, and provide guidance on the form of consent to be received, the manner of notification to partners, the information required in the disclosure, etc.

The information is included in Revenue Procedure 2012-17, which can be found here.

Additionally, the AICPA’s Journal of a Accountancy has prepared a detailed analysis here.

Partners’ Interest Expense Allocation Subject of New Regulations

February 4, 2012

New temporary and proposed regulations issued by the Internal Revenue Service make changes to the way partners allocate and apportion interest expense. The changes affect corporate partners with a 10% or more interest in a partnership as well as certain other partners. The regulations also address allocation and apportionment of interest expense using the fair market value method.

Read more about the new regulations at this article by the Journal of Accountancy.

New Forms for Cost of Goods Sold and Officer Compensation

January 23, 2012

When filing their 2011 tax returns, businesses taxed as corporations or partnerships will notice two new forms attached to their returns.  The IRS has moved the reporting of Cost of Goods Sold to a new Form 1125-A.  Likewise the reporting of officers compensation will be moved to Form 1125-E.  These forms will be attached to either corporate Form 1120 or partnership Form 1065.