The IRS recently issued proposed regulations (REG-136118-15) that will, if implemented, govern the new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113. These new rules apply to partnerships and limited liability companies that are taxed as a partnership for federal income tax purposes.
The new partnership audit rules allow the IRS to assess and collect income tax at the partnership level rather than from individual partners. The new audit rules replace the partnership audit procedures created under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). The new audit rules apply to tax years beginning January 1, 2018.
The Bipartisan Budget Act of 2015 replaced the TEFRA tax matters partner with a partnership representative that must be a person or entity that has a “substantial presence” in the United States. If the partnership or LLC taxed as a partnership fails to designate a partnership representative the IRS may name the partnership representative. This is one of the reasons LLCs taxed as partnerships must amend their Operating Agreement or adopt an Operating Agreement, i.e., to name a partnership representative in the Operating Agreement to prevent the IRS from doing so. The LLC taxed as a partnership cannot change its designated partnership representative without the IRS’s consent.
The partnership representative can be an entity or a person. The partnership representative does not have to be a member of the LLC. After being appointed by the partnership or LLC, the partnership representative must then be designated on the partnership’s or LLC’s tax return.
Take care when appointing a partnership representative because the partnership representative has the sole authority to deal with the IRS on behalf of the partnership or LLC and all of its partners or members with respect to the following matters: (i) settling a tax audit, (ii) agreeing to a final partnership tax adjustment, (iii) making an Internal Revenue Code Section 6226 election to pay a partnership liability at the partner level, and (iv) agreeing to a Section 6235 extension of the period for making partnership adjustments.
The new audit rules take effect January 1, 2018. There are three important take a-ways to be learned from the new partnership audit rules:
- All existing partnerships and limited liability companies taxed as partnerships that have an Operating Agreement need to amend their Operating Agreements to add provisions dealing with the new partnership audit rules and to designate a partnership representative.
- All existing partnerships and limited liability companies taxed as partnerships that do not have an Operating Agreement need to adopt an Operating Agreement that contains provisions dealing with the new partnership audit rules and that designates a partnership representative.
- All new partnerships and limited liability companies taxed as partnerships should adopt an Operating Agreement with the new partnership audit provisions and should designate a partnership representative.
Hire Me to Amend or Prepare an Operating Agreement that Has Partnership Tax Audit Provisions and Designates a Partnership Representative
I’ve made it very easy to hire me to amend an existing LLC Operating Agreement or prepare a new Operating Agreement. The first step to hire me is to complete my online Operating Agreement questionnaire.
If you have questions about adopting or amending an LLC Operating Agreement, call me at 480-664-7478 or send an email to me at email@example.com.
The post IRS Issues Proposed Regulations for New Partnership Tax Audit Rules appeared first on Arizona Limited Liability Company Law.
This week I learned about a now defunct Arizona LLC that was terminated by the Arizona Corporation Commission (the “ACC”) without the prior knowledge or consent of the sole member and manager of the LLC. The Articles of Organization filed with the ACC to create the LLC named Homer Simpson (not the member’s real name) as the member and manager of the manager managed LLC called World Wide Widgets, LLC (not real LLC’s name).
Sometime in 2015 somebody filed Articles of Termination to terminate World Wide Widgets, LLC. The document was not signed by Homer Simpson. It was signed by Bob Faker (not the real name of the signer) who signed as the manager of the LLC. The ACC approved the filing and terminated World Wide Widgets despite the fact Bob Faker was not listed on the records of the ACC as a member or a manager of the LLC.
I notified the ACC about the fraudulent termination of the LLC and this is its response:
“We accept filings at face value, and do not request any verification of authority to act. As you know, we are just a filing agency, not an enforcement agency. We do not investigate or have any authority to enforce any laws with respect to allegations of fraud. We are unable to assist with reinstating this entity. If you were to get a court order requiring reinstatement, we would follow that order”
The fraudulent termination of an LLC could have extremely negative consequences for the members of the terminated LLC. Here are just a few problems that the termination causes:
- The termination would cause the IRS to take the position that the termination caused all of the assets of the terminated LLC to be distributed to the members in the year of the termination. If the value of the distributed assets exceeds the member’s tax basis in the LLC the member has taxable income equal to the value of the distributed assets minus the tax basis. For example, if the LLC’s only asset is a parcel of real property valued at $200,000 and the sole member of the LLC has a tax basis of $100,000, the member has taxable income of $100,000 in the year of the fraudulent termination.
- If the LLC owns assets that have a title, there is no document that evidences a transfer of ownership from the LLC to the member. In the example above, the member would be the beneficial owner of the real estate, but there is no deed signed by the terminated LLC that transfers the title to the land to the member. Because the LLC was terminated, it is not possible for it to sign a deed that transfers title. The member will be forced to file a quiet title lawsuit to get the title changed from the LLC to the member.
- If the terminated LLC has intellectual property such as patents or trademarks those assets will be in limbo.
- The financial history of the terminated LLC will be lost. The member can form a new LLC with the same name, but could not say that the new LLC has been in business since 1995.
I am sure there are many additional problems a fraudulent termination can cause.
Consequence of Filing a False Document with the ACC
Arizona LLC law provides that it is a felony to file a false document with the ACC. Arizona Revised Statutes Section 29-613.A states:
“A person who . . . signs any articles, statement, report, application or other document filed with the [Arizona Corporation] commission that is known to the person as false in any material respect is guilty of a class 4 felony.”
Solution to the Problem
The issue becomes what, if anything, can the members of the terminated LLC do to correct the problem. The answer alluded to by the ACC’s response above is for the members of the LLC to file a lawsuit and ask the superior court to issue an order to the ACC that the ACC reinstate the existence of the terminated LLC and correct its records to reflect that the fraudulent termination of the LLC never occurred.
This sad story reinforces something I have been telling my LLC clients for years: YOU MUST CHECK THE ACC’S WEBSITE AT LEAST ONCE EVERY THREE MONTHS TO CONFIRM THAT ALL THE INFORMATION ABOUT YOUR LLC IS CORRECT. If you find that your LLC was fraudulently terminated then you can file your lawsuit to correct the problem sooner rather than later.
If your LLC was fraudulently terminated, call me at 480-664-7478 or send me an email message at firstname.lastname@example.org
Go the the ACC’s ecorp website to search for your LLC and confirm it exists and all information is correct.
The post Imposter Signs & Files False Articles of Termination & ACC Terminates the LLC appeared first on Arizona Limited Liability Company Law.
Question: My accountant says that I need to turn my LLC into an S corporation. How do I do that?
Answer: First you need to understand that the term “S corporation” refers to a method of income tax under the Internal Revenue Code of 1986. S corporation is one of four federal income tax methods that can apply to a limited liability company.
You do not have to convert your LLC into a corporation. Instead, the LLC simply makes an election with the IRS to have the LLC taxed as an S corporation by having all members of the LLC sign an IRS Form 2553 and then file the signed Form 2553 with the IRS. See the Instructions to IRS Form 2553. If you want your LLC to be taxed as an S corporation for the tax year beginning January 1, 2017, the members must sign and file IRS Form 2553 with the IRS not later than March 15, 2017.
Caution: There are certain requirements that must be satisfied for an LLC to eligible to elect to be taxed as an S corporation. An LLC may to elect to be an S corporation only if it meets all the following tests.
- It is (a) a domestic corporation, or (b) a domestic entity such as an LLC eligible to elect to be treated as a corporation, that timely files Form 2553. If Form 2553 is not timely filed, see Relief for Late Elections, later.
- It has no more than 100 shareholders. You can treat an individual and his or her spouse (and their estates) as one shareholder for this test. You can also treat all members of a family (as defined in section 1361(c)(1)(B)) and their estates as one shareholder for this test.
Its only shareholders are individuals, estates, exempt organizations described in section 401(a) or 501(c)(3), or certain trusts described in section 1361(c)(2)(A).
It has only one class of stock (disregarding differences in voting rights). Generally, a corporation or LLC is treated as having only one class of stock if all outstanding shares of the corporation’s stock or LLC’s membership interests confer identical rights to distribution and liquidation proceeds.
There are other requirements, but the major requirements are listed above. For more about S corporations and LLCs read my blog post called “S Corporation Ignorance.”
P.S. Besides the S corporation federal income tax method, an LLC can also be called taxed as a sole proprietorship (if it has one member or two members who are married and own their membership interests as community property) partnership (if it has two or more members), a C corporation.
The post How Does My LLC become an S Corporation? appeared first on Arizona Limited Liability Company Law.
Question: I own Arizona real estate that I rent to tenants. I don’t want to be sued personally if somebody gets hurt on the property so I formed an Arizona limited liability company to own my investment real estate. If a tenant or guest is injured on the property and he or she wants to sue the owner the defendant will be the LLC not me because the LLC will own the land. What do I have to do to transfer the land to the Arizona LLC?
Answer: Forming an LLC to own the real estate and to shield you from liability if something goes wrong with the real estate is definitely a good idea. The plan, however, will not work unless you actually transfer ownership of the land from the current owner(s) to the LLC. To transfer the land to the LLC the owner(s) must sign a deed and the deed must be recorded with the county recorder of the county in which the real estate is located.
1. Title Insurance Issue #1. Example: After the LLC acquired title it discovers that the property is encumbered by a $25,000 lien. The title insurance policy acquired by the prior owner(s) did not list the lien as an exception from title insurance coverage.
Quit Claim Deed Bad Example. Because the LLC acquired title by a Quit Claim Deed the title insurance policy will not pay the $25,000 lien. A Quit Claim Deed does not contain any title warranties. This means that if a title defect is discovered while the LLC owns the land the LLC does not have a claim against the prior owner for breach of a title warranty. Because the LLC does not have a claim against the prior owner for breach of a title warranty the prior owner’s title insurance policy does not cover the $25,000 lien. The LLC must pay the lien or risk losing the property in a foreclosure.
Warranty Deed or Special Warranty Deed Good Example. A Warranty Deed and a Special Warranty Deed both contain title warranties that if breached give the new owner a claim against the prior owner(s). If a properly drafted Warranty Deed or Special Warranty Deed had been used to transfer title to the LLC the deed would contain a warranty that the land was not subject to the $25,000 lien. The breach of this title warranty gives the LLC a claim against the prior owner(s). Because the LLC has a claim against the prior owner(s) for breach of the title warranty the prior owner(s) could then make a claim under the prior owner(s) title insurance policy and the title insurance company would pay off the $25,000 lien.
2. Title Insurance Issue #2. The LLC should contact the title insurance company that issued the prior owner(s) title insurance and purchase an endorsement to the title insurance policy that names the LLC as an additional insured under the original title insurance policy issued to the prior owner(s) as of the date the prior owner(s) acquired the title insurance. With the endorsement the LLC can make a claim on the title insurance policy directly to the title insurer rather than against the prior owner(s) for breach of a title warranty. This type of endorsement typically costs $75 – $125.
3. Insurance Issue. When the LLC acquires title to the land be sure to contact your insurance company and notify it that the LLC owns the property and arrange for the LLC to be the named insured under the policy or added to the policy as an additional insured. If the property burns to the ground you don’t want the insurance company to deny coverage because it insured the prior owner(s) not the LLC. Make sure the LLC acquires all types of insurance that is appropriate for the property and its use.
4. Due on Sale Clause Issue. If the property is encumbered by a lien, the lender may have an option to call the loan if the borrower(s) transfers title to the LLC. This type of option is called a “due on sale clause.” If you ask the lender for permission to transfer the land to your LLC the lender will always say no. I’ve formed thousands of LLCs that acquired real estate subject to due on sale clauses. I’ve never had a client tell me that their lender called their loan when they transferred their land to their LLC. If you transfer your land to an LLC and your lender calls your loan, please let me know. The good news with respect to Arizona real estate encumbered by a Deed of Trust is that Arizona Revised Statutes Section 33-813.A allows the prior owner(s) to cure the default and stop a trustee’s sale under a Deed of Trust by deeding the property from the LLC back to the prior owner(s) who must also pay the lender its foreclosure costs.
Purchase a Do-It-Yourself Special Warranty Deed
If you need to transfer Arizona real estate to a limited liability company, purchase one of my editable do-it-yourself Word documents for $47. Each deed comes with instructions on how to complete the deed and record it with the appropriate Arizona county recorder. Purchase a deed in my legal forms web form store.
The post How Do I Transfer Real Estate to My LLC? appeared first on Arizona Limited Liability Company Law.
Question: I intend to buy a commercial real estate property. Should I form a corporation to own the real estate?
Answer: No. Nope. Absolutely not. No way. Negative. Are you kidding? Ix nay. Uh-uh. Nah. Not on your life. No way. No way José. Ixnay. I hope you don’t misunderstand my position.
An article in Forbes called “Why You Should Never Hold Real Estate In A Corporation” states:
“Take, for example, the client who contemplates the type of entity that should be used to hold a piece of real estate. For most tax practitioners, this would elicit the following Pavolovian reaction: ‘You should NEVER put real estate inside a corporation.’ And while there are very few NEVERS in the tax world, this one is pretty darn accurate.”
See also “The Perils of Holding Real Estate in a Corporation,” which discusses the federal income tax reasons it is a bad idea for a corporation to own real estate.
The post Should a Corporation Own Real Estate? appeared first on Arizona Limited Liability Company Law.