Capital Account Challenges for Partnerships and LLCs Tackling Targeted Capital Account Calculations, Complex Operating Agreements and Other Tax-Related Issues TUESDAY, JULY 23, 2013, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours . To earn credit you must: • Respond to verification codes presented throughout the seminar . If you have not printed out the “Official Record of Attendance”, please print it now . (see “Handouts” tab in “Conference Materials” box on left -hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form . • Complete and submit the “Official Record of Attendance for Continuing Education Credits,” which is available on the program page along with the presentation materials. Instructions on how to return it are included on the form. • To earn full credit, you must remain on the line for the entire program. For this program, attendees must listen to the audio over the telephone. WHOM TO CONTACT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program : - On the web, use the chat box at the bottom left of the screen - On the phone, press *0 (“star” zero)
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Capital Account Challenges for Partnerships and LLCs July 23, 2013 Leo HItt, Reed Smith Gregory M. Levy, Kaufman Rossin & Co. lhitt@reedsmith.com glevy@kaufmanrossin.com Telma Nadvorny, Ernst & Young telma.nadvorny@ey.com
Today’s Program General Overview Slide 7 – Slide 29 [Telma Nadvorny] Traditional Layered Approach Slide 30 – Slide 42 [Gregory M. Levy] Targeted Capital Account Approach Slide 43 – Slide 59 [Leo Hitt]
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
Telma Nadvorny, Ernst & Young GENERAL OVERVIEW
Partnership Allocations Overview Slide 8
Contrasting Basis And Capital Accounts Outside tax basis Book capital accounts Tax capital accounts Increased by Increased by Increased by Tax basis of contributions FMV of contributions Tax basis of contributions Share of taxable income Share of book income Share of taxable income Share of partnership liabilities Decreased by Decreased by Decreased by Tax basis of distributions FMV of distributions Tax basis of distributions Share of taxable loss Share of book loss Share of taxable loss Slide 9
Section 704 Overview ► Section 704(a): a partner’s share of tax items is determined by partnership agreement ► Section 704(b): ensures that allocations of partnership items match economics of deal (i.e., ensures each partner receives economic benefit or bears economic burden associated with allocations of income and deduction) ► Section 704(c): governs allocations of tax items related to property that has a tax basis different from its §704(b) book value ► Section 704(d): partner is entitled to deduct allocated losses only to extent of partner’s basis in his or her partnership interest at end of year Slide 10
Partnership Agreement: Starting Place For Partnership Allocations ► Includes all agreements ► Among all partners ► Between some partners ► Need not be called “partnership agreement” ► Can consist of more than one document ► May be oral or written ► Includes applicable non-tax law ► In case of hybrids (i.e., U.S. partnership, foreign corp.), should include shareholders’ agreement Slide 11
Allocations Satisfy §704(b) If: ► Substantial economic effect ► Economic effect test requirements must be satisfied ► Allocations must be substantial ► Partners’ Interest in the Partnership (PIP) ► Deemed to be in accordance with PIP (e.g., nonrecourse deductions, tax credits) ► Note: An allocation respected under §704(b) may nevertheless be reallocated under another provision of the Internal Revenue Code (e.g., §482) Slide 12
Slide Intentionally Left Blank
Three Tests For Economic Effect ► Primary test ► Alternate test for economic effect ► Economic equivalence test Slide 14
Economic Effect Test Requirements ► Alternate test ► Primary test ► Capital account maintenance ► Capital account maintenance ► Liquidation in accordance with positive capital accounts ► Liquidation in accordance ► Loss allocation may not cause with positive capital accounts or increase adjusted capital account deficit ► Deficit restoration obligation (DRO) ► Qualified income offset (QIO) Slide 15
Example 1, Stage 1: Capital Account Maintenance – In General Money Op. Co. Co. FMV ATB Cash Equipment $100 $40 $200 Land 100 80 JV Total $200 $120 ► What are the partners’ book and tax capital accounts? Outside basis? What if JV borrowed $300 from Bank, with loan guaranteed by Money Co.? Money Co. Op. Co. Book Tax Basis Book Tax Basis $200 $200 $200 $200 $120 $120 $200 $200 $500 $200 $120 $120 Slide 16
Example 1, Stage 2: Computing JV’s Book Depreciation Money Op. Co. Co. FMV ATB Equipment $100 $40 Cash Land 100 80 $200 Total $200 $120 JV ► Annual tax depreciation on the equipment is $10. What is the annual book depreciation? Slide 17
Example 1, Stage 3: Reflecting Partnership Income/(Loss) Year 1 Activity: Money Co. Op. Co. ► Operating income - $40 50% 50% ► Operating expenses - $240 ► Tax depreciation - $10; Book - $25 JV ► Long-term gain on sale of land - $20 ► Current distributions - $30 Cash Land Equipment ► Assume all split 50-50 FMV=200 FMV=100 FMV=100 ATB=200 ATB=80 ATB=40 Money Co. Op. Co. Book Basis Book Basis Beginning $200.0 $200.0 $200.0 $120.0 (100.0) (100.0) Net. op. loss (100.0) (100.0) (12.5) (0.0) Depreciation (12.5) (10.0) Gain on sale 0.0 0.0 0.0 20.0 Distributions (15.0) (15.0) (15.0) (15.0) Ending $72.5 $75.0 $72.5 $25.0 Slide 18
Capital Account Maintenance: Revaluations Of Partnership Property ► Reasons needed: ► Maintain relative economic interests of the partners ► Prevent capital shifts ► Mandatory vs. optional ► Mandatory for property distributed to a partner ► Optional for all assets on contributions, distributions, and in accordance with industry standards for securities partnerships ► Differences created between partners’ book and tax capital accounts; must be taken into account under §704(c) principles Slide 19
Liquidating Distributions ► Must be made in accordance with the partners’ positive capital account balances ► Determined after taking into account all capital account adjustments for partnership taxable year during which liquidation occurs ► Generally, must be made by the earlier of: ► The end of the year of liquidation ► Ninety days following the date of liquidation Slide 20
Deficit Restoration Obligation ► Requires partner with deficit capital account balance upon liquidation of his partnership interest to unconditionally restore the amount of such deficit ► Actual DRO in partnership agreement Or ► Deemed DRO ► State law requirements ► Promissory notes of partner or related entity that are contributed to partnership ► Unconditional obligation to contribute ► Ultimate payor on partnership recourse debt ► Minimum gain Slide 21
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