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Jim Browne
WAGNER KIRKMAN BLAINE KLOMPARENS & YOUMANS LLP Mather, CA 916.920-5286 x810 chess@wkblaw.com
Jim Browne
STRASBURGER & PRICE, LLP Dallas, TX 214.651.4420 jim.browne@strasburger.com December 8, 2015
Introduction Self-employment tax implications for LLC members Treatment of limited partners under 3.8% taxes Planning opportunities Planning opportunities Proposals and changes on the horizon
6
Supplemental Taxes (before 2013)
FICA/SET Employment tax on wages (“FICA”)
15.3% on base amount (indexed)*; 2.9% on excess Paid ½ by employer and ½ by employee Paid ½ by employer and ½ by employee
Tax on earnings from self-employment (“SET”)
15.3% on base amount (indexed and adjusted for wages); 2.9% on excess
Investment income
No supplemental tax
*$110,100 for 2012 8
Supplemental Taxes (current law 2013)
FICA/SET/Medicare/NII Employment tax on wages (“FICA”)
15.3% on base amount (indexed)*; 2.9% on excess Paid ½ by employer and ½ by employee
Additional 0.9% employee tax on excess wages of high-income
Additional 0.9% employee tax on excess wages of high-income
individuals
Tax on earnings from self-employment (“SET”)
15.3% on base amount (indexed and adjusted for wage income); 2.9% on
excess
Additional 0.9% tax on excess self-employment earnings of high-income
individuals
Investment income
3.8% tax on net investment income of certain high-income taxpayers*
*$118,500 for 2015 9
Application of FICA and SET additional tax
Affected (high-income) taxpayers
Individuals with wages and/or self-employment income in excess of:
$250,000 joint
$250,000 joint
$125,000 separate $200,000 individual and other
Additional tax applies only to the aggregate wages and self-
employment income in excess of the specified amounts
Thresholds are not indexed for inflation Corporations, estates, and trusts are exempt
Additional tax is subject to withholding or estimated tax
payments along with regular FICA or SET
10
Additional Tax – Starting 1/1/2013. Applies to: individuals, estates and trusts
and: Sch K-1 entity reporting
Compute 3.8% Additional Tax x the lesser of: Compute 3.8% Additional Tax x the lesser of:
(1)
Total NII (net investment income), or
(2)
Excess MAGI*
*Excess MAGI = “MAGI minus Threshold Amount.
Total NII is after deduction for portion of Sched A, Form 1040 expenses (investment expenses, alloc. state income taxes)
11
Status
Threshold Amount
Married filing jointly
Married filing jointly
Married filing separately
Single
Head of household
Qualifying widow(er) with child
12
NII then passes to beneficiary
13
$300,000 NII (rental income) $190,000 AGI (had a business loss)
NII Tax = $0. 3.8% x lesser of (1) $300K NII or (2) $0.0*
*(190K AGI – 200K Threshold)
14
$300K NII; $190K AGI (business loss) No beneficiary distribution (no DNI Distribution)
3.8% NIIT Computation:
NII Tax = $6,752.60. 3.8% x lesser of (1) $300K NII or (2) $177,700* *(190,000 MAGI – 12,300 Threshold)
But, if $177,850 DNI distributed,
NII Tax = $0.0 ($12,150 AGI)
15
Application of NIIT (con’t)
Exempt taxpayers: Corps, foreign trusts, and TE or
charitable trusts
Partnerships and S corporations are not subject to NIIT, but Partnerships and S corporations are not subject to NIIT, but
the income of such entities may be subject to NIIT in the hands of the owners
Distributions from foreign trusts may be subject to NIIT in the
hands of the beneficiary
SET overlap: NII excludes income subject to SE tax Estimated tax: NIIT included in calculation of required
installments
16
– FEW CHANGES
NOT “day traders”.
Reduces value of security/commodity traders tax benefits
17
Normal related deductions (e.g., expenses for rentals) “1040 Schedule A” deductions (phase-outs)
State Income Taxes (allocate) Investment Interest Expenses (related) Other investment expenses (e.g., advisor fees) (related)
18
Common types of excluded income
Interest income on tax exempt bonds Income from qualified retirement plans Social security benefits Social security benefits Alimony Wages and self-employment income
19
Issue:
Can an LLC member treat any portion of the member’s
distributive share of LLC income as exempt from SET under the exception for limited partner distributive share under the exception for limited partner distributive share income? The issue is relevant only for LLC members who materially participate in the LLC business or can otherwise avoid NIIT on the distributive share income
21
The SET limited partner exception - 1402(a)(13)
In computing net earnings from self-employment:
Include the “distributive share (whether or not distributed) of
income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member” business carried on by a partnership of which he is a member”
Exclude (in addition to normal exclusions for rents, dividends,
gains, etc.):
“the distributive share of any item of income or loss of a limited
partner, as such,
that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services”
22
Purpose for the limited partner exception
Before enactment of 1402(a)(13) in 1977, persons ineligible for
social security benefits were buying passive, limited liability investments in partnerships that promised to generate self- employment income eligible for such benefits employment income eligible for such benefits
Congress enacted 1402(a)(13) to curtail “buying” social
security benefits through limited partner investments
While the statute targets passive limited partners earning
investment type income, the statute is not limited to such persons
The statute expressly contemplates that a limited partner
may provide services to the partnership and earn a guaranteed payment for such services and still have distributive share income excluded from SET and related benefit accruals
23
The 1997 proposed regulations
Context:
Traditional restrictions on limited partner management activities
eroding
Growing use of alternative forms of tax partnerships with full or partial
limited liability for managing members (LLCs, LLPs, and LLLPs) limited liability for managing members (LLCs, LLPs, and LLLPs)
Increasing SET rate relative to benefits
General rule: a “limited partner” is any individual unless the
individual:
has personal liability as a partner for the partnership’s debts, or has authority (under the law of the jurisdiction in which the partnership
is formed) to contract for the partnership, or
participates in the partnership's business for more than 500 hours
during the partnership’s taxable year, or
is a service partner in a service partnership
24
The 1997 proposed regulations (con’t)
Class of Interest Exceptions
An individual holding more than one class of interest is a limited
partner with respect to a class of interest in which (a) limited partners (as defined above) own a substantial (≥20%), continuing interest and (b) the individual’s rights are identical to such limited interest and (b) the individual’s rights are identical to such limited partners’ rights
An individual holding only one class of interest who is not a
limited partner solely because he participates in the business for >500 hours is a limited partner with respect to the interest if (a) and (b) above are true with respect to the class of interest
These exceptions are intended to “exclude from an individual's net
earnings from self-employment amounts that are demonstrably returns on capital invested in the partnership”
A service partner in a service partnership is never a limited partner
to any extent (i.e., no class of interest exception)
25
Congress responds
The 1997 proposed regulations sparked a firestorm of
criticism
Critics claimed that earnings from self-employment must be limited
to the fair value of the services actually rendered to the business, and should not sweep in all income derived from the business based on should not sweep in all income derived from the business based on arbitrary factors such as the number or hours worked or the nature
Congress promptly passed legislation prohibiting finalization
under 1402(a)(13) until July 1, 1998
The Senate bill expressed the Senate’s view that the proposed
regulations should be withdrawn and that “Congress should determine the tax law governing self-employment income”
26
Case law and rulings
Passive activity loss cases
Several cases (see slide 47) address the question whether an LLC
member is a “limited partner” for purposes of the passive activity loss rules (material participation test) [Reg. 1.469-5T(e)] loss rules (material participation test) [Reg. 1.469-5T(e)]
All cases hold that an LLC member is not a limited partner Could those cases be applied in the context of 1402(a)(13)?
The reasoning of the cases is dubious and was likely
influenced by the questionable validity of the temporary regulations, which were modified in 2011
Should not be authoritative for SET purposes
27
Case law and rulings (con’t)
SET cases and rulings
Renkemeyer, Campbell & Weaver, LLP v. Comm’r, 136 T.C. 137 (2011)
Law firm organized as a general partnership electing LLP status Abusive facts: transitory corporate holding company; missing Abusive facts: transitory corporate holding company; missing
partnership agreement; failure to allocate income and distributions according to alleged sharing ratios; low or no compensation for services
Dubious reasoning: Court discusses the legislative history of 1402(a)(13) Intent to exclude “earnings that are basically of an investment nature” The legislative history “does not support a holding that
Congress contemplated excluding partners who performed services for a partnership in their capacity as partners”
Because the taxpayers’ distributive share income arose exclusively from
legal services performed on behalf of the partnership, and was not “of an investment nature,” the income was subject to SET
28
Case law and rulings (con’t)
SET cases and rulings
Riether v. United States, 919 F. Supp. 2d 1140 (D. NM 2012)
LLC operates a medical diagnostic imaging business; members
receive wages and distributive share income from the LLC; no SET on distributive share (<$10,000 tax effect) distributive share (<$10,000 tax effect)
Taxpayers assert they can’t be self-employed because they received
wages
No evidence that members lacked management authority, or that
wages were reasonable compensation for services
Held: distributive share income is subject to SET because taxpayers
were effectively general partners
“Plaintiffs are not members of a limited partnership, nor do they resemble
limited partners, which are those who ‘lack management powers but enjoy immunity from liability for debts of the partnership.’ [Renkemeyer] Thus, whether Plaintiffs were active or passive in the production of the LLC's earnings, those earnings were self-employment income.”
29
Case law and rulings (con’t)
SET cases and rulings
Howell v. Comm’r, 2012 T.C. Memo 303
Medical technology company (LLC) formed by W and B; H (W’s
spouse) managed the business with B; LLC paid guaranteed payments to H, B, W and others, leaving only small amounts of distributive to H, B, W and others, leaving only small amounts of distributive share income for W and B; no SET paid on guaranteed payments
H&W “appear to contend” that W was a limited partner not active in
the business and her guaranteed payments were either limited partner distributive share income or not payments for services
Held: Taxpayers are bound by their tax reporting (guaranteed
payment)
W performed some services for the LLC, but failed to prove what
portion of the guaranteed payments were for services
Notably, no SET imposed on distributive share income 30
Case law and rulings (con’t)
SET cases and rulings
CCA 201436049 (May 20, 2014)
Investment fund management company organized as an LLC;
members were paid a salary, a guaranteed payment for parking and health benefits, and a distributive share; no SET on distributive share health benefits, and a distributive share; no SET on distributive share
Members contributed varying amounts of capital to the LLC Held: entire distributive share income is subject to SET because the
income “is not income which is basically of an investment nature
enacted the predecessor to § 1402(a)(13). Accordingly, [the members] are not limited partners within the meaning of § 1402(a)(13).”
No analysis whether the salary and guaranteed payments
represented reasonable compensation for services
No analysis whether the distributive share income was attributable
to capital contributions, profits on employee labor, or other non- service factors
31
Where are we now?
Reporting position: an LLC member’s distributive share
income from a manager-managed LLC is exempt from SET if the member is paid reasonable compensation for services as a manager manager
This position is easily reconciled with the statute and legislative
history, including the arguments that led to the 1997 Congressional moratorium
It is consistent with the treatment of S corporations It is consistent with the recent cases on their facts IRS position that distributive share income of an active partner is
always subject to SET is plainly contrary to the statute, Congressional intent (as expressed in 1997), and its litigating position in Howell Service partners in service partnerships have more risk
32
33
Effective 1/1/2013. Applies to: individuals, estates and trusts
Compute 3.8% Additional Tax x the lesser of:
(1)
(2)
*Excess MAGI = “MAGI minus Threshold Amount.
34
PSC/Closely Held “C” Corps
Subject to § 469 – PAL Limitations Subject to § 469 – PAL Limitations But Not NIIT
35
S Corp Holders/Partners (Indiv/Trusts/Estates)
36
NII results if partner’s T/B income
IRS Statement – Will NOT follow all §469 exceptions:
“Even if the taxpayer meets one of the
37
IRS will not apply following 469 active T/B presum’ns:
§ 1.469-1T(e)(3)(ii) (Deemed T/B - 6 items)
“Start-up” activity presumed T/B “Predevelopment revenue” Not active T/B for NII “Predevelopment revenue” Not active T/B for NII
Example 3b: Developer leaseback to farmer land held for
income will be deemed NII.
Note – expect developers to claim
they are farmers.
38
Real estate professional (>750 hrs) +
*Activity Must be Part of That Active Trade or Business
39
Real estate professional (>750 hrs) +
*Activity Must be Part of That Active Trade or Business
40
Real estate professional (>750 hrs) +
If prove it’s a T/B , then it’s not subject to §1411. *Activity Must be Part of That Active Trade or Business
41
BUT: Limited Partners: §469(h)(2)
Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an partnership as a limited partner shall be treated as an interest with respect to which the taxpayer materially participates.
And 469(h)(6)(c) says the same thing as to active
42
Two Part Analysis to Get Around:
1.
Is the interest “classified” as a limited partner interest for tax purposes? for tax purposes?
2.
If “classified”, does the limited partner meet one of 3 exceptions?
43
So, to avoid NIIT, partner must both:
qualify as real estate professional and either (i) NOT be deemed a limited partner, or
(ii) meet an exception due to substantial activities. (ii) meet an exception due to substantial activities.
Affected: Interests in LLCs, LPs, LLPs, LLLPs, other
Definition of Limited Partners by Statute?
(self-employment tax exception)
44
How classify/“define” a limited partner.
State Law vs. Tax Law Old Kintner Regulations not useful:
Continuity of Life Continuity of Life Transferability limitations? Limited liability Centralized Management
Littriello v. US (6th Cir. 2007). Treasury does not have to
follow state law for taxpayer-businesses; and can set own rules where Congress not clear and unambiguous.
45
Limited Partner Defined: Temp Reg. 1.469-5T(e)(3)(i)
...interest [is] a limited partnership interest if— (A) …. designated a limited partnership interest in the (A) …. designated a limited partnership interest in the limited partnership agreement or the certificate of limited partnership, ….; or (B) The liability of the holder … for obligations of the partnership is limited, ….. … interest … shall not be treated as a limited partnership interest …. if the individual is a general partner.
46
But courts declined LP treatment for LLC members:
Gregg v. U.S., 186 F.Supp.2d 1123 (D. Or. 2000). LLC. Garnett v. Com’r, 132 T.C. 368 (2009). LLPs and LLCs were not limited partnerships. not limited partnerships. Thompson v. U.S., 87 Fed. Cl. 728 (2009). 469(h)(2) requires a partnership. An LLC member is not a limited partner. Newell v. Com’r, T.C. Memo. 2010-23. 469(h)(2) did not apply to the managing member of an LLC. Member is a general partner under §1.469-5T(e)(3)(ii). Lamas v. Com’r, T.C. Memo 2015-59. Several LLCs & S Corp. Rejects no material participation. Aggregates S Corps & LLC activities – total hours adequate.
47
But Proposed Treas. Reg. 1.469-5(e)(3)(i) (11/28/11)
http://www.irs.gov/pub/irs-utl/2015-2016_pgp_initial.pdf
48
If interest is “classified” as a limited partner, IRC §
Three exceptions:
Taxpayer works 500 hours or more in the particular Taxpayer works 500 hours or more in the particular
trade or business activity.
Taxpayer materially participated in the activity in any 5
It is a personal service activity; taxpayer materially
participated in that activity in any 3 prior years.
Did the IRS eliminate test #3 for NII purposes???
49
50
IRS position vs. taxpayers
51
IRS: Material participation by nongrantor trust depends on
trustee’s activity, not it’s agents (or special trustee) 1. BUT
1Position discussed by IRS in TAM 200733023; PLR 201029014; TAM 201317010.
Carter Trust v. US 256 F. Supp. 2d 536 (N.D. Tex. 2003).
Trustee hired ranch manager. Material participation found through employees and trustee.
Aragona Trust v. Com’r, 142 TC. 9 (3/27/14). 3 of 6 trustees
(related) worked FT for R/E management LLC, wholly owned by trust. Trust can materially participate through trustee- employees; R/E professional exception applied.
52
Same Issue/Same Framework? Material Participation & Real Estate Professional:
Partnership - Determined at Partner Level
Trust – Determined at Trustee Level (if trustee does
Trust – Determined at Trustee Level (if trustee does
material activities + agents activities.
Unclear:
R/E Pro Exception – Trust. If agents provide services,
are they counted?
treated as “active” for beneficiaries @ distribution?
53
Distributions from IRA/Roth not s/t 3.8% NIIT
Can hold Real Estate as Investment
Caution: real estate held poses possible issues:
UBIT (Tax at Trust Rates – 39.6% @ $12,300 TI) UBIT (Tax at Trust Rates – 39.6% @ $12,300 TI) Actively “Trade”– Plan Disqualification Inurnment – Plan Disqualification Prohibited Self-Dealing No Capital Gains
Schieck, Structuring Real Estate Investments to Avoid the
Net Investment Tax, 41 J. Real Estate Tax’n (Q1 2014)
54
55
Using an S corporation to avoid SET/NIIT
The properly determined distributive share income of an
S corporation engaged in an active non-trading business is unquestionably exempt from both SET and NIIT
BUT
S corporations have significant disadvantages. (e.g., one class
721/731 exclusion for gain on property contributions and distributions, no inside basis step-up at death, etc.)
The perceived SET/NIIT benefits may be overstated A properly structured LLC/LP should achieve similar SET
benefits.
56
S corporation election for an LLC or LP
Tax preparers or other tax advisors often elect S
corporation status for an LLC or LP solely to obtain SET and NIIT advantages. This is usually bad advice! and NIIT advantages. This is usually bad advice!
Same considerations as any S corporation (see prior slide) Plus additional potential problems if the company agreement
is not modified to conform to S corporation requirements; the entity might be classified as a C corporation!
57
S corporation blocker
What if the LLC/LP interests are owned by single member S corps?
Individual A Individual B Individual C
Individuals are employees of LLC or S corp and are paid wages Distributive share income flows through S corporations NB: Cumbersome and does not eliminate all disadvantages of
S corporation ownership
S Corp 1 S Corp 2 S Corp 3
S Corp. S Corp. S Corp.
LLC
Partnership
58
A properly structured LLC/LP
Individual A Individual B Individual C
Individuals perform services for LLC as employees of Manager Distributive share income received by individuals as an LLC
member having no management rights
Same structure can be used for a limited partnership
(Manager is the general partner)
59
Manager
S Corp. (or LLC)
Manager-Managed LLC
Partnership Management Fees
Spousal split ownership of LLC/LP
Taxpayer Spouse
Managing Member Member
T’s activities are imputed to S for passive activity
purposes, but are not imputed to S for purposes of SET limited partner proposed regulations
S’s distributive share income should avoid SET/NIIT
60
OpCo, LLC
Partnership Active non-trading, non- service business Member 1% Member 99% Guaranteed Payment for Services
One class of interest exception
Taxpayer Others
Managing Member Member
based on material participation
61
OpCo, LLC
Partnership Active non-trading, non- service business Member
80% 20%
Guaranteed Payment for Services
Grouping
One or more business activities may be treated as a single
activity (“grouped”) if the activities constitute an “appropriate economic unit” for the measurement of gain or loss for purposes of Section 469 [Reg. 1.469-4(c)(1)]
Appropriate economic unit depends on facts and circumstances
Appropriate economic unit depends on facts and circumstances Generally, use any reasonable method to group activities Five factors are given the greatest weight in determining whether
activities constitute an appropriate economic unit:
Similarities or differences in the types of businesses; Extent of common control; Extent of common ownership; Geographical location; and Interdependence of the activities 62
Limitations on grouping
A rental activity can’t be grouped with a trade or business
activity unless they form an appropriate economic unit and
Rental activity is insubstantial in relation to business activity; Business activity is insubstantial in relation to rental activity; or Common ownership
Can’t group real property rental activity with personal
property rental activity
Special rules for special industry activities described in
Section 465(c)(2) (film, depreciable person property leasing, farming, oil and gas, and geothermal property)
63
Special NIIT re-grouping election
A one-time regrouping election is available during the
first taxable year that NII exceeds the threshold amounts (first time Form 8960 would be filed) [Reg. 1.469-11(b)(3)(iv)] (first time Form 8960 would be filed) [Reg. 1.469-11(b)(3)(iv)]
Taxpayers may regroup on an amended return if the
taxpayer was not subject to NIIT on original return (or previously amended return) and, if, due to a change to the original return, the taxpayer owed NIIT for that taxable year
64
Limitations on grouping
Final regulations do NOT allow regrouping by partnerships
and S corporations
Opportunity for regrouping – 2nd Bite (different taxpayer) Opportunity for regrouping – 2
Bite (different taxpayer)
Estate/Trust @ 1st Spouse’s Death Sub-Trust Funded for Children Distribution of property out of trust/estate
65
Planning
Under prior law, it was often advantageous to not group
activities (to accelerate use of suspended losses on activities sold or terminated) activities sold or terminated)
Under current law, it might be beneficial to group
activities so that otherwise passive activities that do not generate self-employment income can become part of an Active Non-Trading Business that generates neither NII nor self-employment income
66
Self Charged Interest. On self-charged interest from an active (non-passive)
The exclusion amount = the lender’s “share of the
nonpassive deduction”. The rule cross-references §1.469– 7 for the operative mechanics.
The limit is inapplicable if the interest deduction is part
tax under section 1401(b)).
67
Self Charged Interest.
68
Property s/t “Self-Charged” Rent
Rental income treated as non-passive under §1.469–
2(f)(6) (rental income from property used in an activity in which the taxpayer materially participates), including in which the taxpayer materially participates), including rental property grouped with a non-passive activity, will be deed T/B income.
Gain/loss from rental property, if sold with active T/B
property will also be treated as nonpassive T/B gain
69
Property s/t “Self-Charged” Rent
Yes, under 1.469-2(f)(6), amount of rent paid by the firm will be treated as non-passive. The self-rental regulations do not require “mirror” ownership.
70
Avoiding NIIT through material participation
Participation by Hours > 500
Time spent (Self/Spouse) Proof of Participation. Appointment book calendar, or Proof of Participation. Appointment book calendar, or
narrative summary. To show the services performed & hours.
Facts & Circumstances Test (difficult)
Activity regular, continuous, and substantial Works at least 100 hours in the activity, No one else works more hours No one else receives compensation for managing the activity
71
Exclusions
Per IRS – Exclude:
Time to i) review financial statements, ii) analysis for personal use,
and iii) monitoring (non-managerial) capacity does not count
Owner work that would normally be assigned to an employee Travel Time Thomas E. Truskowsky, T.C. Summary Op 2003-130
Per IRS: Few taxpayers can meet the facts and circumstances
circumstances test cannot be used.
Are these position over-reaching? An on-site manager for 100
unit apartment defeats active T or B!!???
72
A high income individual having a non-managing
LP/LLC interest in a passive activity can generally avoid SET and NIIT on distributive share income if participation in the activity exceeds 100 hours but is less participation in the activity exceeds 100 hours but is less than 500 hours (i.e., is significant but not material)
The individual’s distributive share income is exempt from SET
(unless the individual has management authority or is a service partner in a service partnership) [Prop. Reg. 1.1402(a)-2]
The individual’s distributive share income may be exempt from
NIIT under the income recharacterization rules for profitable significant participation activities [Reg. 1.1411-5(b)(2)(i)]
73
Net Gain from Dispositions
Opportunities to reduce losses by:
Strategies to reduce NII by Sec.165 losses: abandonment and
worthlessness. worthlessness.
Culling of losses.
Basic exceptions/limitations/exclusions apply
Loss limitations (at risk, basis, but capital loss C/F rules are
narrower)
Installment sale rules Statutory Exclusions apply – 1031/1033/1038/121(home)
Look Through Rule:……
74
Owner’s “Disposition” of Interest in Pship or S Corp
1411(c)(4) & (Prop. Treas. Reg. 1.1411-7). Recasts NII gain/loss as business gain/loss.
(A) gain from such a disposition shall be taken into account…only to the extent of the net gain…if all property of the partnership or S corporation were sold at fair market value immediately before the disposition of such interest, and (B) a rule similar to the rule of subparagraph (A) shall apply to a loss from such disposition.
75
How: “look-through”: Had entity its assets (“deemed sale”)
at FMV, what portion would be business income? (Prop. at FMV, what portion would be business income? (Prop.
Trade/business portion is excluded from NII “net gain from
disposition”.
Complicated Computation - difficult to qualify.
NOTE!: Does not apply to owner of C Corp!
76
Summary
T’s gain from sale of interest is bifurcated:
if part of gain from sale relates to trade/business portion sold,
total gain included in NII is reduced (negative adjustment) total gain included in NII is reduced (negative adjustment)
T’s loss bifurcated: if part of loss from sale relates to
trade/business sold, total loss is reduced – offset against
“Excess” = deemed investment gain/loss
Note: Adjustment doesn’t increase total gain or total
77
sale;
asset (including goodwill);
through);
(i) net investment income and (ii) excluded income (e.g., trade or business income.)
78
AB Tax Consultants – B Has Basis of $75,000
B (75%) Sells Interest to C for
79
A (25%)
Interest to C for $90,000
AB Partnership A/B Assets = $120K
Step 1. B’s Gain = $15,000. ($90,000 – 75,000) Step 2. AB Pship Built in Gain=$20,000 ($120 - $100K basis)
B’s share (75%) = $15,000 (same)
If B active in T/B, 100% active T/B Gain; and. Therefore 100% excluded from NII
NII from disposition = $0.00
80
Assets: Investment $5,000 gain (25%)
Tangible $15,000 gain (75%)
75% x $15,000 = $12,500)
NII = $3,500 ($15,000 - $12,500 excluded)
81
B’s share is $15,000
Deemed sale gain cannot increase the loss.
82
Installment Sales Section 1031 Exchanges Charitable Donation of Appreciated Property Distributing investment assets Distributing investment assets Successor Trusts (active Trustee) – see above Spreading Investment Income (Family Limited
Partnerships & LLCS)
Suitable Investments Managing Estate or Trust Distributions Creating Material Participation in Passive Activities
83
84
Joint Committee SET proposal (2005)
Repeal limited partner exception Partner that does not materially participate pays SET
Investment income of a service partnership is subject to
SET
S corporation is treated as a partnership for SET
purposes
85
American Jobs and Closing Tax Loopholes Act (2010)
Impose SET on distributive share income of each shareholder
services with respect to the professional service business of the S corporation
Disqualified S corporation:
Disqualified S corporation:
S corporation that is a partner in a partnership engaged in a
professional services business and substantially all activities are in connection with such partnership
S corporation engaged in a professional services business if the
principal asset is the reputation and skill of three or fewer employees Impose SET on any limited partner who provides substantial
services with respect to a a partnership engaged in a professional services business
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CBO SET proposals (2012)
Material participation standard
SET imposed on distributive share income of all partners who
materially participate Reasonable compensation standard Reasonable compensation standard
SET imposed only on reasonable compensation paid to owners
(same as for S corporations)
Reduces SET revenues by estimated 58% (based on underreporting
Safe-harbor calculation of capital income
Apply a prescribed rate of return to balance sheet net operating
assets
Would not apply to S corporations No accounting for intangibles and other off-balance sheet income
producing assets
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Carried interests
Would treat a partner’s distributive share of net income
partnership interest” (“ISPI”) as ordinary income or loss partnership interest” (“ISPI”) as ordinary income or loss
ISPI = interest held by a person providing a substantial
quantity of investment management services with respect to partnership specified assets (securities, real estate, partnership interests, and commodities)
Amount characterized as ordinary income or loss is
subject to SET
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Obama/Treasury proposal(pre-Fiscal Cliff)
Return of Kintner Regs. – entity choice not for tax red’n.
House Tax Reform Proposals (2013)
Option 1: revise rules for S Corps and P’ships
Option 1: revise rules for S Corps and P’ships
Does not address SET
Option 2: Adopt 1 set of rules for S Corps and P’ships
Would require some rule characterizing distributive share
income
GOP (2014)
SET applies to 100% distrib. share, GP, LP, S Corp, LLC
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July 31, 2015 IRS 2015-2016 Priority Guidance Plan
Final Regulations Under Section 469(h)(2) – Ltd P’ships Finalize open portions of Section 1411 regulations
AICPA Proposals to Treasury AICPA Proposals to Treasury
Clarify material participation Clean up of regulations/statutory reform
Obama’s Buffet Rule (30% min tax on TI > $1 million Bush Proposal – elim. 6.2% employee SET on seniors.
No change to LPs/LLCs (Reform Corps & PIT)
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AICPA requesting Treasury clarify material participation by a trust/estate:
Incorporate the conclusions reached in the two court decisions; Count all activities of any trustee or executor, irrespective of capacity and
irrespective of whether the individual owns an interest in the same;
Count the activities of employees and agents employed; Allow Temp. Reg. § 1.469-5T(a) material participation tests to apply to
trusts/estates;
Allow Temp. Reg. § 1.469-5T(a) material participation tests to apply to
trusts/estates;
Deem period estate materially participating if owner materially participated b/4
death;
Treat trust/estate’s income character and beneficiary’s distributions the same; Allow beneficiary participation in QSST to determines if QSST gain from a sale
Allow both the S portion and the non-S portion of an ESBT to be a single trust
for §469 rules.
Allow a trust/estate to be a real estate professional under §469(c)(7) and state
how.
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AICPA also requested the following:
Threshold Amounts. Increase and allow inflation CPI;
make optional simplified reporting available to more.
Simplify Losses. Allow taxpayers to opt to include all Simplify Losses. Allow taxpayers to opt to include all
gain or excluding all loss disposition under look-through disposition rule for pass-through entities.
Create Safe Harbor for Tiered. Provide a simplified safe
harbor method for tiered pass-through dispositions
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This document is not intended to provide advice on any
specific legal matter or factual situation, and should not be relied upon without consultation with qualified professional advisors.
Any tax advice contained in this document and any
attachments was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under applicable tax laws, or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter.
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Jim Browne
WAGNER KIRKMAN BLAINE KLOMPARENS & YOUMANS LLP Mather, CA 916.920-5286 x810 chess@wkblaw.com
Jim Browne
STRASBURGER & PRICE, LLP Dallas, TX 214.651.4420 jim.browne@strasburger.com