ch17
TRANSCRIPT
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Tax 4022/5022 Tax 4022/5022 Federal Income Tax IIFederal Income Tax II
Dr. Robert R. OlivaProfessor and ChairpersonDepartment of Accounting
University of Arkansas at Little Rock
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How to obtain class files:How to obtain class files:
http://www.cba.ualr.edu/rroliva/indexrr.html
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Corporate Income Taxation Corporate Income Taxation
Miscellaneous TopicsMiscellaneous Topics
Copyright, 1996 © Dale Carnegie & Associates, Inc.
TIP For additional advice seeDale Carnegie Training® Presentation Guidelines
I. The Corporation as an Entity: Types
II. Corporate Taxation
III. Corporations v. Other Entities
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I. The Corporation as an I. The Corporation as an Entity: TypesEntity: Types
“C” corporations: Regular corporations “S” corporations Why “C” v. “S”?
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Organization of USC Title 26Organization of USC Title 26
Subtitle– Chapter
Subchapter– Part
• Subpart
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SUBTITLESSUBTITLES
A: INCOME TAXES B: ESTATE AND GIFT F; PROCEDURE AND
ADMINISTRATION
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Subtitle A (divided into Subtitle A (divided into CHAPTERS)CHAPTERS)
1: NORMAL TAXES 2: SELF EMPLOYMENT TAXES 6: CONSOLIDATED RETURNS
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Chapter 1 (divided into Chapter 1 (divided into Subchapters)Subchapters)
– A: TAX LIABILITY– B: COMPUTATION OF TAXABLE INCOME– C: CORPORATE DISTRIBUTIONS AND
ADJUSTMENTS– K: PARTNERS AND PARTNERSHIPS– S: TAX TREATMENT OF S
CORPORATIONS AND THEIR SHAREHOLDERS
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Defining the “C” corporationDefining the “C” corporation
State law Federal law
– Check the Box Regulations
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State lawState law
De jure v. de facto Define responsibilities Define dissolution events
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Federal law: Federal law:
IRC: 7701(a)(1)-(3) Check the box regulations Morrisey v. CIR
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IRC 7701(a)(1)-(3)IRC 7701(a)(1)-(3)
IRC: corporations includes associations What does that mean?
– Treas. Regs– Cases
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Treas. Reg. 301-7701-4Treas. Reg. 301-7701-4
Applicable to resolve issues of whether the business entity should be taxed as one of the following:– Sole proprietorship– Partnership– Corporation
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Types of corporate entitiesTypes of corporate entities
“Per se” corporations Not ‘per se” corporations = associations
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““Per se” corporationsPer se” corporations
De jure Specifically included foreign corporations
– Generally not closely held, publicly traded
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Not “per se” corporations = Not “per se” corporations = associations associations
AKA: eligible entities – Domestic– Unincorporated
Partnerships LLC
– Nonpublicly traded May choose classification Failure to choose: default rules
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Choosing classificationChoosing classification
Membership > 2: corporation or partnership Membership = 1: corporation or sole
proprietorship
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Default rules:Default rules:
Incorporation on or after 1/1/97:– Membership > 2: partnership– Membership = 1: sole proprietor
Incorporation before 1/1/97:– Membership > 2 : use old regulations– Membership = 1: sole proprietorship
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Choosing statusChoosing status
Form 8832
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II. Corporate TaxationII. Corporate Taxation
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Corporate rates: IRC 11Corporate rates: IRC 11
15%; 25%, 34%, and 35%– 15%: >$0 to $50K– 25%: >$50K to $75K– 34%: >$75K to $10MM– 35%: >$10MM
But also: two surtaxes to eliminate savings from lower brackets:– Add 5%when TI >$100k up to $11,750
Creates a rate “bubble”: 39% MTR between $100K-$335K
– Add 3% when TI> $15MM up to $100K Creates a rate “bubble” of 35% when TI >$18.3MM:
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Organization of USC Title 26Organization of USC Title 26
Subtitle– Chapter
Subchapter– Part
• Subpart
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SUBTITLESSUBTITLES
A: INCOME TAXES B: ESTATE AND GIFT F; PROCEDURE AND
ADMINISTRATION
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Subtitle A (divided into Subtitle A (divided into CHAPTERS)CHAPTERS)
Chapter 1: NORMAL TAXES
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Chapter 1 (divided into Chapter 1 (divided into Subchapters)Subchapters)
– Subchapter A: TAX LIABILITY– Subchapter B: COMPUTATION OF TAXABLE
INCOME– Subchapter C: CORPORATE DISTRIBUTIONS
AND ADJUSTMENTS– Subchapter K: PARTNERS AND PARTNERSHIPS– Subchapter S: TAX TREATMENT OF S
CORPORATIONS AND THEIR SHAREHOLDERS
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SUBCHAPTER C divided into SUBCHAPTER C divided into Parts Parts
PART I: DISTRIBUTIONS BY CORPORATIONS
PART II: CORPORATE LIQUIDATIONS PART III. CORPORATE
ORGANIZATION AND REORGANIZATIONS
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PART I: DISTRIBUTIONS BY PART I: DISTRIBUTIONS BY CORPORATIONSCORPORATIONS
SUBPART A: EFFECT ON RECIPIENTS: IRC 301-307
SUBPART B: EFFECT ON CORPORATION: IRC 311 AND 312
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PART II: CORPORATE PART II: CORPORATE LIQUIDATIONSLIQUIDATIONS
SUBPART A: EFFECT ON RECIPIENTS: IRC 331-334
SUBPART B: EFFECT ON CORPORATION: IRC 336-338
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PART III. CORPORATE PART III. CORPORATE ORGANIZATION AND ORGANIZATION AND REORGANIZATIONSREORGANIZATIONS
SUBPART A: CORPORATE ORGANIZATION: IRC 351
SUBPART B: EFFECT ON SHAREHOLDERS: IRC 354-358
SUBPART C: EFFECT ON CORPORATION; IRC 361-362
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CORPORATE TAX CORPORATE TAX FORMULAFORMULA
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Corporate Tax FormulaCorporate Tax FormulaCorporate Tax FormulaCorporate Tax FormulaGross incomeLess: Deductions (except charitable, Div. Rec’d, NOL carryback,
STCL carryback) Taxable income for charitable limitationLess: Charitable contributions (< = 10% of above)Taxable income for div. rec’d deductionLess: Dividends received deductionTaxable income before carrybacksLess: NOL carryback and STCL carrybackTAXABLE INCOME
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SUBCHAPTER B: SUBCHAPTER B: COMPUTING TAXABLE COMPUTING TAXABLE
INCOMEINCOME IRC 63(a):
– TAXABLE INCOME = GROSS INCOME LESS DEDUCTIONS
GROSS INCOME: IRC 61– SPECIFIC INCLUSIONS: IRC 71-86– SPECIFIC EXCLUSIONS: IRC 101-135
DEDUCTIONS: IRC 161-197
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CORPORATE DEDUCTIONSCORPORATE DEDUCTIONS
IRC 162: ORDINARY AND NECESSARY DIFFERENCES SPECIAL CORPORATE DEDUCTIONS
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DIFFERENCES FROM DIFFERENCES FROM INDIVIDUALSINDIVIDUALS
– NO FLOOR ON MISCELLANEOUS DEDUCTIONS [IRC 167: 2% OF AGI]
– NO STANDARD DEDUCTIONS
– NO DEPENDENT
– NO HOBBY LOSS LIMITATIONS
– NO INVESTMENT INTEREST LIMITATIONS
– NO CASUALTY LOSSES LIMITATIONS
– CHARITABLE. CAPITAL GAINS/LOSSES, AND NOL DEDUCTIONS COMPUTED DIFFERENTLY
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Capital gains/losses:Capital gains/losses:
Corp: Capital gains taxed as all other income
Corp: Capital losses cannot be reduce other income but it can reduce capital gains.
Net Capital Losses: Carry Back/Forward (and treat as ST cap. loss) – Method: Carry back to third previous year; 2d
previous; last year; and then for the next 5 years.
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NOLsNOLs
Carry Back/Forward May elect to carry-back 2 years, otherwise
carry forward 20 years. – DRD included in NOL computation
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The Corporate Income TaxThe Corporate Income Tax
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SPECIAL CORPORATE SPECIAL CORPORATE DEDUCTIONSDEDUCTIONS
IRC 243: DRD IRC 246 IRC 248 IRC 267 IRC 291
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IRC 243: DRDIRC 243: DRDIRC 243: DRDIRC 243: DRD
70% DRD IF % OWNERSHIP < 20% 80% DRD IF % OWNERSHIP = 20% TO
<80% 100% DRD IF % OWNERSHIP 80% OR
MORE
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IRC 246: DRD LIMITATIONS; IRC 246: DRD LIMITATIONS; OWNING < 20%: OWNING < 20%:
DRD LIMITED TO THE LESSER OF– 70% DIV RECEIVED, OR– 70% OF TI BEFORE THE DRD, NOL,
AND/OR CAP. LOSS CARRYBACK BUT NO LIMIT WHEN DRD
GENERATES OR ADDS TO AN NOL
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EXAMPLEEXAMPLE
CORP RECEIVES $200 DIV ENTITLED TO A 70% DRD, $300 DEDUCTIONS
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IF GROSS INCOME = $400IF GROSS INCOME = $400
TIBDRD: 400 + 200 - 300 = $300 70% OF TIBDRD = .7($300) = $210 70% OF DIV = .7($200) = $140 *
LESSER OF 70% OF TIBDRD OR 70% OF DRD = $140
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IF GROSS INCOME = $280IF GROSS INCOME = $280
TIBDRD: 280 + 200 - 300 = $180 70% OF TIBDRD = .7($180) = $126* 70% OF DIV = .7($200) = $140 LESSER OF 70% OF TIBDRD OR 70%
OF DRD = $126
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IF GROSS INCOME = $ 220IF GROSS INCOME = $ 220
TIBDRD: 220 + 200 - 300 = $120 70% OF TIBDRD = .7($120) = $84 70% OF DIV = .7($200) = $140* LESSER OF 70% OF TIBDRD OR 70%
OF DRD = $140? $140 BECAUSE IT WILL GENERATE
AN NOL: $120-$140 = ($20)
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Other DRD ExamplesOther DRD ExamplesOther DRD ExamplesOther DRD Examples
Z Corp owns 60% of X Corp’s stock in years 1, 2 & 3. Dividend of $200 is received each year. Limit (Step 2) is 80% x $200 = $160.
1 2 3_
Income 400 301 299
Dividend rec’d 200 200 200
Expenses (340) (340) (340)
Income before DRD 260 161 159
80% of income 208 129 127
Year #1 $208 > $160, so $160 is DRD
Year #2 $129 < $160, so $129 DRD
Year #3 DRD causes NOL ($159-$160), so $160 DRD is used. $2 less income results in $30 more DRD
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IRC 248: ORGANIZATIONAL IRC 248: ORGANIZATIONAL EXPENDITURESEXPENDITURES
ELECTION– IF NOT MADE WITH FIRST RETURN,
THEN DEDUCT IN LIQUIDATION OVER NOT LESS THAN 60 MONTHS
– STARTING WITH THE FIRST MONTH OF OPERATIONS
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EXAMPLE:EXAMPLE:
INCORPORATION ON 7/1 STARTS BUSINESS ON 8/1 ELECTS YEAR END OF 9/30
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EXPENSESEXPENSES
(1) 6/10: $2K, CHARTER EXPENSES (2) 7/17: $40K, COMMISSIONS (3) 7/18: $2K, CPA FEES (4) 7/20: $1K, TEMP DIRECTORS (5) 8/25: $2K, REGULAR DIRECTORS (6) 12/31: $1K, MODIFY CHARTER
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NOT INCLUDED:NOT INCLUDED:
(2): PAID-IN CAPITAL: EXPENSES FOR SELLING SECURITIES AND TRANSFER OF ASSETS
(5): ORDINARY AND NECESSARY DEDUCTION
(6): INCURRED DURING SECOND YEAR
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INCLUDED:INCLUDED:
(1); (3); AND (4) = $5,000 $5000 OVER 60 MONTHS =
$83.33/MONTH ONLY TWO MONTHS IN FIRST YEAR:
2 ($83.33) = $$166.66
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IRC 267: LOSSES, IRC 267: LOSSES, EXPENSES, AND INTEREST EXPENSES, AND INTEREST
BETWEEN RELATED BETWEEN RELATED TAXPAYERSTAXPAYERS RELATED?
EFFECT
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RELATED TAXPAYERSRELATED TAXPAYERS
>50% OWNERSHIP CONSTRUCTIVE OWNERSHIP
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CONSTRUCTIVE CONSTRUCTIVE OWNERSHIP: IRC 267(c)OWNERSHIP: IRC 267(c)
– A.F.E. %: ATTRIBUTION FROM ENTITY = PROPORTIONATELY
STOCK OWNED BY A CORP, PART, EST, OR TRUST OWNED PROPORTIONATELY BY SHAREHOLDERS, PARTNERS, OR BENEFICIARIES.
– INDIVIDUAL CONSIDERED OWNING STOCK OF BROTHERS/SISTERS, SPOUSE, ANCESTORS, AND LINEAL DESCENDANTS, AS WELL AS HIS PARTNER.
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REATTRIBUTION REATTRIBUTION
STOCK OWNED DUE TO A.F.E., CONSIDERED AS OWNED BY SHAREHOLDER, PARTNER, OR BENEFICIARY, TO REATTRIBUTE TO OTHERS.
STOCK OWNED DUE TO PARTNERSHIP OR FAMILY RELATIONSHIP CANNOT BE RE-ATTRIBUTED TO OTHERS.
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IRC 267(d): SUBSEQUENT IRC 267(d): SUBSEQUENT RESALE TO A THIRD PARTYRESALE TO A THIRD PARTY REDUCE SUBSEQUENT GAIN FROM
RESALE BY PREVIOUSLY DISALLOWED LOSS
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IRC 1239: GAINS BETWEEN IRC 1239: GAINS BETWEEN RELATED TAXPAYERSRELATED TAXPAYERS
COVERT CAPITAL GAINS INTO ORDINARY INCOME
USES IRC 267 CONSTRUCTIVE OWNERSHIP RULES
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III. Other business entitiesIII. Other business entities
Sole propietorships Pass-Through Entities
– Partnerships– S corporations– LLCs
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Sole propietorshipSole propietorship
One owner No separate existence
– No independent tax significance or consequence Income and expenses retain their character
– Owner contributes and withdraws property without tax effect
Reported: Form 1040; Sch. C Business MTR = individual’s MTR
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AdvantagesAdvantages
No independent taxation Losses serve as tax shelter to other income
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DisadvantagesDisadvantages
Net profit taxed to owner when reported whether received or not– Taxed on re-invested profits
Owner is not an employee– Self-employment tax
Same tax year No liability shield
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Pass-Through EntitiesPass-Through Entities
Partnerships S Corporations LLCs
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Partnerships: DefinitionPartnerships: Definition
State law Federal law
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Partnership definition: UPA Partnership definition: UPA (local law):(local law):
“… an association of two or more persons...”
“… to carry on as co-owners ….” It is not sufficient:– to have a mere co-ownership, particularly a
passive activity investments– sharing profits: needs co-ownership
“… a business for profit”
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Partnership definition: Federal Partnership definition: Federal tax law: IRC 761(a)tax law: IRC 761(a)
“.. Includes a syndicate, group, pool, joint venture or other unincorporated organization …”
“… through of by ... Which any business, financial operation, or venture is carried on ….”
“… and which is not … a corporation, or a trust or estate….”
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Partnerships: Subchapter KPartnerships: Subchapter K
2 or more persons Independent entity from owner
– Income & Expenses to partners in K-1’s: Non-separately Stated and Separately Stated
– Partner liable for share for allocable share, irrespective of distribution
Conduit/flow through: does not pay taxes– Exceptions: BIG and PAI– Must file an Information Return: Form 1065
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Advantages of a PartnershipAdvantages of a Partnership
Entity is tax exempt– Entity’s MTR = partner’s MTR; good if
partner’s MTR < corp’s MTR Partners able to withdraw and contribute
affecting only adjusted basis Partners’ basis increases by allocable share
– Reduces gain on sale Debt basis
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DisadvantagesDisadvantages
Net profit taxed to owner when reported whether received or not– Taxed on re-invested profits
Owner is not an employee– Self-employment tax
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Effect of “Check the Box” Effect of “Check the Box” regulationsregulations
Business entities with > 1 member may elect to be taxed as partnership or corporation.
But if there is a failure to elect, classification is pursuant to the default rules. – If >1 member: partnership
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Types of partnershipTypes of partnership
– General – Limited– Family partnerships– Publicly traded partnership
taxed as corporations unless > 90% of gross from qualifying passive income
traded in public markets
– Electing large partnerships partners > 100 Not in service business; not commodity trading
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Family PartnershipsFamily Partnerships
Real or sham?– Two kinds of partnerships based on what is the
material income producing factor capital services
In service partnership, a partner family member must provide substantial services
In capital intensive partnerships: no as much of a problem
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LLCs: Limited Liability LLCs: Limited Liability CompaniesCompanies
State created entity Taxation (as a partnership)
– Elect to be taxed as a partnership under “check the box”
Unlike partnerships (and similar to corporations): members have limited liability
Unlike limited partners: LLC members may participate in management
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Advantages of LLC’s (versus Advantages of LLC’s (versus S)S)
not limited to a specific number of members– <2005: 75– > 2005: 100
not limited to one class of stock not limited to kinds of shareholders Non-shareholder debt basis
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Additional advantages of Additional advantages of LLC’s (versus S)LLC’s (versus S)
LLC able to make disproportionate allocations and distributions [IRC 704]
LLC able to distribute appreciated property to members without recognition of gain [IRC 731(b)]
Has similar provision as IRC 351, without the need of control and can be used at anytime without concern for control [IRC 721].
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Advantages of LLC’s (v. LP’s) Advantages of LLC’s (v. LP’s)
No need for GP with personal liability All members have limited liability All members may participate in
management
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Advantages of LLC’s (v. GP’s)Advantages of LLC’s (v. GP’s)
LLC members do not have personal liability
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Advantages of LLC’s (v. Sub Advantages of LLC’s (v. Sub C’s)C’s)
LLC’s may be taxed as pass through entities by electing under “check the box” to be taxed as a partnership
Has similar provision as IRC 351, without the need of control and can be used at anytime without concern for control [IRC 721].
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Conversion to LLCConversion to LLC
From partnership: no tax consequences From corporation: requires liquidation and
tax event
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Other similar entities: Other similar entities:
Limited Liability Partnership Publicly traded partnerships
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Limited Liability PartnershipLimited Liability Partnership
Like GP: severally and jointly liable for LLP’s liabilities arising out of other than malpractice.
From partnership to LLC: no tax consequences
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Publicly traded partnershipsPublicly traded partnerships
PTP avoided double tax because not taxable at entity level
PTP’s classified/taxed as associations– Exception: When > 90% of gross derived from
passive-type income
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S CorporationsS Corporations
Hybrid Advantages/disadvantages
– Very similar to partnerships– Very similar to corporations