Single Owner LLC, Analytical comparison between Saudi System and US system.
mo053598
c5.pdf
Citation: G. P. Dimminich; Halsey O. Schreier, Re-Thinking the LLC, 26 S.C. Law. 43, 55 (2014) Provided by: <br>SMU Underwood Law Library
Content downloaded/printed from HeinOnline
Mon Oct 9 15:47:52 2017
-- Your use of this HeinOnline PDF indicates your acceptance of HeinOnline's Terms and Conditions of the license agreement available at http://heinonline.org/HOL/License
-- The search text of this PDF is generated from uncorrected OCR text.
-- To obtain permission to use this article beyond the scope of your HeinOnline license, please use:
Copyright Information
Use QR Code reader to send PDF to your smartphone or tablet device
RE-THINKING THE LLC
In today's high-tax environment, practitioners should explore having
active member(s) in an LLC make the S corporation tax election.
By G.P Diminich and Halsey 0. Schreier
Practitioners have felt comfortable advising clients to choose the lim- ited liability company (LLC) because of its ease of organization, flexibility, elimination of annual reporting requirements and rela- tive lack of corporate formalities. Moreover, because default income tax classification rules treat the LLC as a "pass-through" entity (i.e., one not taxed at the entity level as a partnership or disregarded entity) and require no independent tax election, most practitioners believed that failing to evaluate other tax elections was irrelevant and without material consequence. While the belief that the LLC's default partnership or disregarded entity tax treatment is ideal from an income tax perspective is certain- ly true in most instances, entirely ignored in this analysis is the employment tax regime.
Until recently, practitioners paid little attention to the fact that another type of "pass-through" tax election could be made for the LLC: the Subchapter S corporation (S cor- poration). While "pass-through" for income tax purposes, the S corpora- tion is also treated favorably from a self-employment tax perspective
under current tax law, unlike part- nership or disregarded entity tax classifications. The distinction is critical, as the Affordable Care Act a/k/a "Obamacare" raised self- employment taxes. By considering having the LLC make a Subchapter S election with the Internal Revenue Service for members who are active owners in the LLC, signifi- cant self-employment tax savings may be recognized while maintain- ing many advantages a LLC entity provides. Potentially, these savings may also largely offset the increased income taxes under the American Taxpayer Relief Act.
Background Because of its many benefits,
the LLC is easily the entity of choice in South Carolina. According to data made available to the authors from the S.C. Secretary of State, LLCs comprised well over 90 percent of 2013's major entity formations. The 24,451 domestic LLCs formed last year represented an amazing increase of 21.5 percent from just two years earlier; by comparison, the 1,961 corporations incorporated in 2013 represented a 11.5 percent decline from 2011. Only 207 limited
partnerships were established in the most recent year. Considering that South Carolina adopted the Uniform Limited Liability Company Act (ULLCA) less than 20 years ago (in 1996), this reliance on LLCs is even more astounding.
The preference of practitioners and clients (who do not need to hire an attorney to file the Articles of Organization) for LLCs has been assisted by the Internal Revenue Service (IRS), whose default rules treat LLCs as pass-through entities for income tax purposes. Around the same time as the passage of the South Carolina ULLCA, the IRS and the U.S. Treasury Department announced in Notice 95-14 a pro- posal to simplify the classification regulations to allow taxpayers to treat unincorporated business organizations as partnerships or as corporations on an elective basis. Effective January 1, 1997, they final- ized what are now called the "Check-the-Box" Regulations.1
Under these new regulations, any business entity, such as an LLC, that is not required to be treated as a corporation for federal tax purposes may choose its classification under these regulations. Absent an affir-
November 2014 43
mative election via the IRS Form 8832 Entity Classification Election to be taxed as a corporation, an LLC, by the default rules, will be taxed as a partnership if it has at least two members or as a disregarded entity separate from its owner if it has just a single member.2 Partnership tax or disregarded entity treatment both confer "pass-through" income tax status on the LLC.
What is self-employment tax? Self-employment tax is a tax
consisting of Social Security taxes and Medicare surtaxes primarily for taxpayers who work for themselves. For 2014, the first $117,000 of a tax- payer's combined wages and net earnings are subject to the Social Security tax of 12.4 percent. Additionally, all of a taxpayer's com- bined wages and net earnings in the current year are subject to the 2.9 percent Medicare surtax. Under the Affordable Care Act (ACA), an addi- tional Medicare surtax rate of 0.9 percent (for a total of 3.8 percent) went into effect and applies to
wages and earned income above the threshold amount (discussed below).
The ACA and ATRA TWo major pieces of federal tax
legislation became effective in 2013, leading many tax experts to believe that S corporations will now emerge as the preferred entity for closely held businesses. 3 After passage of the ACA, the IRS itself projected that the S corporation would go from a plurality of tax elections presently to a substantial majority by 2019. 4 To understand why the S corporation is becoming the preferred tax entity for certain taxpayers in light of recent tax leg- islation, a very brief analysis of both recent tax laws is necessary.
First, effective January 1, 2013, the ACA increased the Medicare surtax on "earned" income (i.e., self-employment related income) to 3.8 percent for certain income earners. Specifically, the ACA, as amended by Section 1402(b)(1)(B) of the Health Care and Education Reconciliation Act of 2010, amend-
ed Section 3101(b) of the Internal Revenue Code to impose an addi- tional 0.9 percent Medicare surtax on the earned income of high- income taxpayers above certain thresholds. For single taxpayers, the threshold is modified adjusted gross income of $200,000 per year and for married taxpayers, $250,000 (for those that file sepa- rately, it is $125,000).
Moreover, there is no limit on the amount or compensation or self-employment income subject to the new Medicare surtax. Perhaps most importantly from a tax plan- ning perspective, the threshold amounts are not indexed for infla- tion, which means more taxpayers will be affected by this new tax in future years.'
Second, on the same day as the ACA, the inaptly named American Taxpayer Relief Act of 2012 (ATRA), also became effective. ATRA increased the maximum marginal individual income tax rate from 35 percent to 39.6 percent for individ- ual taxpayers having taxable
The best thing for your resume since spellcheck.
An online LL.M. concentration in Taxation or BusinessTransactions from The University of Alabama School
of Law allows you to earn an advanced degree while working full-time. Enrolling in this program demonstrates that
you understand the value of live classes made available in a collaborative, online environment and accessible from
anywhere in the world. Earning this degree proves that you received skills-based training from respected professors
and practitioners throughout the country, and that you are prepared to be a leader in your field.
Visit AlabamaLLM.ua.edu/sc to learn more.
Online LL.M. degree programs Tax and Business Law Concentrations
I*
LL.M. ALABAMA 0 Q The University of Alabama
• School of Law
AlabamaLLM.ua.edu/sc
44 SC Lawyer
income over $400,000 ($406,750 in 2014) and for married couples fil- ing jointly having taxable income over $450,000 ($457,600 in 2014).6
For those filing separately, the highest income tax bracket begins at $228,800.
More important to a larger pool of taxpayers, ATRA imposed a num- ber of "stealth" tax increases for tax- payers at lower income leuels. The effective tax rates of individual tax- payers having threshold adjusted gross income of $250,000 and cou- ples with $300,000 were increased as a result of the reinstatement of the phase-outs on itemized deduc- tions and personal exemptions. As to phase-outs, ATRA reinstated the "Pease" limitation on itemized deductions, so the affected taxpay- ers above must reduce their item- ized deductions by three percent of the amount by which the taxpay- er's income exceeds the threshold amounts above (subject to some limitations). As to personal exemp- tions, the total exemptions of a tax- payer are reduced by two percent
for each $2,500 by which that tax- payer's income exceeds the thresh- olds above.7
Together, the ACA and ATRA imposed significant new tax increases on many self-employed taxpayers. The most affected self- employed taxpayers not only saw their itemized deductions and exemptions phased out, but their total nominal tax rates increase by up to 8.6 percent (3.8 percent under the ACA and 4.6 percent under ATRA).
A self-employed taxpayer active in her LLC's business, however, has a major tool at her disposal to miti- gate her overall tax burden: elect- ing S corporation status.
Members of LLCs with DartnershiD
ship, however characterized that income may be." While there is a narrow exception to this rule for a "limited partner," it is inapplicable to LLC members who participate in the LLC's business more than 500 hours in a year.9
Therefore, because a partner's entire distributive share of the partnership's (or disregarded enti- ty's, as the case may be) income is subject to self-employment tax, an unmarried LLC member filing his return as single is subject to 12.4 percent Social Security tax on income up to $117,000, 2.9 percent Medicare surtax on income up to $200,000 ($250,000 if the member is married and files jointly), and then 3.8 percent ACA Medicare sur- tax on income thereafter.
or disregarded tax entity treat- ment are subject to self-employ- "Materially participating" mem- ment taxes on all pass-through bers of LLCs with S corporation partnership income distributions. treatment may avoid self-employ-
As a general rule, self-employ- ment taxes on all pass-through S ment income includes a partner's corporation income distributions. entire distributive share of pass- Conversely to partnership and through income from a partner- disregarded entity tax treatment,
November 2014 45
the IRS has long held that an S cor- poration shareholder's distributive share of the corporation's pass- through income is not subject to self-employment tax.10
As long as a shareholder is active (in tax parlance, "materially participates") in the S corpora- tion's business, then the dividend distribution(s) the shareholder receives will likely not be subject to either Medicare surtax (i.e., not the 3.8 percent ACA Medicare sur- tax nor the 2.9 percent, if the shareholder's income is lower than the ACA threshold levels). A taxpayer "materially participates" in an activity if she works on a regular, continuous and substan- tial basis in operations." Material participation is time sensitive. A taxpayer materially participates in an activity only if she meets any one of the seven material partici- pation tests listed in 26 C.F.R. § 1.469-ST(a):
1. The taxpayer works 500 hours or more during the year in the activity.
2. The taxpayer does substantially all the work in the activity.
3. The taxpayer works more than 100 hours in the activity during the year and no one else works more than the taxpayer.
4. The activity is a significant par- ticipation activity (SPA), and the sum of SPAs in which the tax- payer works 100-500 hours exceeds 500 hours for the year.
5. The taxpayer materially partici- pated in the activity in any five of the prior 10 years.
6. The activity is a personal service activity and the taxpayer materi- ally participated in that activity in any three prior years.
7. Based on all of the facts and cir- cumstances, the taxpayer partic- ipates in the activity on a regu- lar, continuous and substantial basis during such year. However, this test only applies if the tax- payer works at least 100 hours in the activity, no one else works more hours than the taxpayer in the activity, and no one else receives compensation for man- aging the activity
Furthermore, and critical especially for taxpayers under the ACA thresh- old amounts, "materially participat- ing" S corporation shareholders are generally also not subject to Social Security taxes on their distributive share of S corporation income or on S corporation dividend distributions, as long as "reasonable compensa- tion" was paid to them as "salary." In other words, 12.4 percent is saved on the amount under $117,000 the S corporation shareholder can justi- fy as reasonable. These savings are in addition to the 2.9/3.8 percent Medicare surtax savings on divi- dend distributions.
Therefore, the tax savings for electing S corporation status for an LLC in 2014 and justifying "reason- able compensation" are: 12.4 per- cent Social Security taxes up to $117,000 in salary, 2.9 percent Medicare surtax on all dividend distributions up to the $200,000/$250,000 threshold, and 3.8 percent ACA Medicare surtax on all dividend distributions above the $200,000/$250,000 threshold.
Purely for illustrative purposes,
SMITHMOORE LEATHERWOOD
ATTORNEYS AT LAW
Mediator,1 Services
Ove 2 yar meito exeine
25 au Sre, Suit 250 1 Ch arlstn S 90
46orey aC Lawyewrmihmoelwo
PROBATE RESEARCH
Missing and Unknown Heirs Located
No Expense to Estate
3tic and International Servi Courts
Lawyers Trust Officers
Administrators/Executors
1345 Wiley Road, Suite 121, Schaumburg, IL 60173 Phone: 847-519-3600 Fax: 800-946-6990
Toll-free: 800-844-6778
www.landexresearch.com
Domes ice for:
consider the following simple example: Assuming a single tax- payer in 2014 with a justifiable salary of $100,000 and dividend distributions of $150,000 from the S corporation, the savings are as follows: 12.4 percent on $17,000 ($117,000-$100,000), 2.9 percent on $150,000 ($250,000-$100,000) and 0.9 percent (for a total of 3.8 per- cent) on $50,000 ($250,000- $200,000), which arrives to $6,908 (or 3.5 percent of total income) in self-employment tax savings. Importantly, these are potentially recurring, annual tax sauings (gener- ally, while half of self-employed taxes are deductible in calculating for adjusted gross income, these income tax savings may mitigate but would not offset the self- employment tax burden).
Reasonable compensation The IRS, of course, has the
authority to reclassify dividend dis- tributions to the S corporation shareholder as compensation (i.e., wages) subject to self-employment tax, as long as it deems compensa- tion inadequate or unreasonable. The critical issue, then, is to deter- mine what wage or salary amount is "reasonable compensation" and avoids self-employment taxes on the dividend distribution(s) a shareholder receives from the S corporation. How does a practition- er go about accomplishing that?
Unfortunately, neither the Internal Revenue Code nor the Treasury Regulations provide specif- ic guidance. Courts have long held that the question of reasonable compensation is one of fact and determined on a case-by-case basis. In a recent case, the U.S. Court of Appeals for the Eight Circuit identi- fied various factors courts have con- sidered in determining "reasonable compensation." Besides the taxpay- er's intent, other factors were:
1) the employee's qualifications; 2) the nature, extent and scope of
the employee's work; 3) the size and complexities of the
business; 4) a comparison of salaries paid
with the gross income and the net income;
5) the prevailing general economic conditions;
6) comparison of salaries with dis- tributions to stockholders;
7) the prevailing rates of compen- sation for comparable positions in comparable concerns;
8) the salary policy of the taxpayer as to all employees; and
9) in the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years.12
A soon-to-be published article in the Journal of Corporate Taxation pro- vides a thorough discussion of recent case law in the "reasonable compensation" arena.13 For its part, the IRS a few years ago issued vague guidance in the form of a "Fact Sheet," which lists the follow- ing factors in determining "reason- able compensation" for S corpora- tion shareholders:
" Training and experience " Duties and responsibilities • Time and effort devoted to the
business " Dividend history * Payments to non-shareholder
employees * Timing and manner of paying
bonuses to key people • What comparable businesses pay
for similar services • Compensation agreements " The use of a formula to deter-
mine compensation 14
Given the uncertainty of all these factors, it is strongly recommend- ed that practitioners consult a Certified Public Accountant (CPA) who ideally is also designated as a Certified Valuation Analyst (CVA) or Accredited in Business Valuation (ABV). These profession- als provide an analysis of how much compensation is "reason- able." It is extremely unwise to rely on a client's opinion as to what salary constitutes "reasonable compensation," and an attorney is typically not in a position to make
this determination. Engaging these accounting professionals not only reduces the risk of allocating improperly low compensation to the S corporation's shareholder, it also justifies the client's compen- sation in case of an IRS audit.
According to Missy Johnson, CPA, CVA, MAFF and Whit Kinder, CPA/ABV, CVA of Elliott Davis, LLC, a CPA firm, they approach a rea- sonable compensation analysis beginning with industry bench- marks from research databases (such as Economic Research Institute, MGMA Physician Compensation and Production Survey, and Bureau of Labor Statistics information). The infor- mation obtained from these data- bases often provides a range of possible compensation for a partic- ular position. These industry benchmarks occasionally may be skewed for a variety of reasons or may not be completely comparable to the subject company; addition- ally, industry benchmarks are not always available for every compa- ny. Consequently, professional
November 2014 47
judgment is a significant part of their analysis, and they often con- sider adjustments to the available benchmarks or lean towards one end of the indicated range of com- pensation. Some of the company specific factors they consider when analyzing the available bench- marks include, but are not limited to, the following:
" the structure of the company, " the company's management team, " the experience, unusual skills
and traits of the individual, * other employees under
management, * the profitability of the company, " any defined bonus or incentive
plans for the individual, " any significant achievements
accomplished (such as negotiat- ing favorable contracts, exceeding targeted profitability levels, improving cash flows, etc.),
" the region and metropolitan areas, and
" the projected growth or expan- sion of the company.
Additionally, they also consider the purpose of the compensation analy- sis. In certain circumstances, it may be appropriate to provide their client with a range for a reasonable compensation. In turn, the client may be best positioned to consider their analysis and determine the amount of compensation to be paid based on its comfort levels, the company's cash flows and any risks related to excessive compensation or minimal compensation.
Risk factor of the S corporation election-legislative or regulatory changes
A number of times in recent years, Congress has had legislation introduced making all S corpora- tion income subject to self-employ- ment tax, most recently with Rep. Pete Stark introducing H.R. 3840, The Narrowing Exceptions for Withholding Taxes Act of 2012. However, Congressman Stark was in the minority party and does not serve in Congress any longer. It appears that, in the U.S. House at
least, no legislation modifying self- employment tax with regard to S corporations will pass.
However, the Obama Administration, in its annual "Green Book" publication, stated that the "taxation of employment income earned by owners of pass-through entities is outdated, unfair, and inef- ficient. It treats business owners differently according to the legal form of their ownership and the legal form of the payment that they receive.""5 Imagine that: one is taxed differently by the form of entity selected. Consequently, some busi- ness owners pay employment taxes on nearly all their earnings (general partners and sole proprietors), other similarly situated owners pay employment taxes on only a por- tion of their earnings (S corporation owner-employees), and others pay little employment tax at all (limited partners and many [passive] LLC members). Thus, many owners of pass-through entities successfully avoid payroll tax on income that is equivalent to self-employment
Chapter 7 and Chapter 13 Aggressive and compassionate for my clients:
More than 20 lawsuits prosecuted or defended in bankruptcy court-two amicus briefs in two major prior cases Actively involved in the Care Program, a credit education program for students
Filed bankruptcy petitions for more than Promotes Dave Ramsey credit education principles 2,000 clients since 2002 Appointed to Chapter 13 Committee and twice appointed to the Interest Rate Committee by the U.S. Bankruptcy Court
More than 12 posted opinions on the U.S. Bankruptcy website
Frequent bankruptcy lecturer-more than 11 CLE lectures since 2009
Active bankruptcy blogger at danielstonelaw.com
Offices in Irmo and Florence
o .... Q ....~ L~ ~ ~ /~ 0 La
48 SC Lawyer
earnings and that would be subject to employment taxes if the business had a different legal structure.16
The Administration offers a remedy in which "[d]istributions of compensation to owners of profes- sional service S corporations ... would be included in earnings sub- ject to [self-employment] taxes."'7
The Green Book proposes that the Treasury Department "would" have authority to issue regulations to implement this "legislation," effec- tive for taxable years beginning after December 31, 2014.18 As of this writing, the Administration has taken no affirmative steps to introduce any legislation and, con- sequently, Treasury has not prom- ulgated such regulations.
Requirements for S corporation status and when to file S corpora- tion election with the IRS
To qualify for S corporation sta- tus, the corporation must meet the following requirements:
* Be a domestic corporation that is
not an ineligible corporation (pur- suant to the "Check the Box" rules and Form 8832 Entity Classification Election, an LLC may be treated as a corporation);
* Have only allowable shareholders (including individuals such as U.S. citizens and resident aliens, certain tax-exempt organizations, certain trusts and estates, but excluding partnerships, corpora- tions or non-resident aliens);
" Have no more than 100 share- holders; and
" Have only one class of stock (N.B.: an S corporation may have voting and non-voting stock; however, its shares must confer identical rights to distribution and liquidation pro- ceeds § 26 C.F.R. § 1.1361-1(l)).1
9
The election must be made on the IRS Form 2553 Election by a Small Business Corporation and submitted to the IRS no later than the 75 day into the taxable year for which the entity desires S corporation status.2 0 All shareholders must consent to this election.
2 1
Rev. Proc. 2013-30 generously allows for late S corporation elections
For those clients having exist- ing, qualifying business and wishing to make a "late" S corporation elec- tion for this year but have not yet done so, new IRS guidance may help. The IRS has recently issued Rev. Proc. 2013-30, which generously allows for "late" S corporation elec- tions. For example, if an existing LLC wants to make the S corpora- tion election for the 2014 tax year, it generally has until March 15, 2014, to do so. If the entity desires to make the election later in 2014, Rev. Proc. 2013-30 grants relief for such a late election (pursuant to a proper filing) and is made effective January 1, 2014. Indeed, Rev. Proc. 2013-30 permits the taxpayer go back up to three years and 75 days and make the proper election if all the follow- ing conditions are met:
The entity intended to be classi- fied as an S corporation, is an eli- gible entity, and failed to qualify
ADVERTISEMENT
any way you want it... ... that's the way you get it.
__ __IL LAWESW K
South Carolina Lawyers Weekly now gives you the latest legal news in the format you select. Get your must-have info from the print newspaper. Or get it from our new website, which
adapts to the device you wish to use- laptop, tablet or smart phone. It's your choice!
South Carolina Lawyers Weekly- making it easy for you to get the news you need, any way you want it.
SUBSCRIBE TODAY] Call 800-451-9998 (mention promo code SCLAW)
or visit https://subscribe.sclawyersweekly.com/SCLAW
November 2014 49
J.M. BRINKLEY, MBA RETIREMENT SPECIALIST
Value Added Services for your Clients
" Pre/Post Divorce Retirement Analysis " Lump Sum Settlement Recommendations " Optimization of Social Security Benefits
0HR~TN SOT 0ARLN
as an S corporation solely because the election was not timely;
" The entity has reasonable cause for its failure to make the elec- tion timely; and
" The entity and all shareholders reported their income consistent with an S corporation election in effect for the year the election should have been made and all subsequent years.2
Negatives of S corporation v. part- nership tax elections
Electing to tax an LLC as an S corporation is not a panacea for all situations. There are still advan- tages to the use of Subchapter K (partnership tax). Subchapter K allows for more flexibility and does not have the restrictions on forma- tion that an LLC making an S cor- poration election faces. With part- nership tax treatment, there are no limits on the number of partners; S corporations can only have 100 shareholders.23 Subchapter K has no restrictions on who can be a partner; generally, with few excep-
G0ing...Going...GONE The Bar Foundation is seeking contributions for its silent auction which, this year, will run throughout the SC Bar Convention. Popular items include vacation homes, jewelry, artwork and rounds of golf.
Caling All Lawyer Artists! New to this year's auction will be a section featuring the work of lawyers who also are artists. Paintings, handmade jewelry, pottery, sculptures.. .we would love to showcase your work.
Please contact 803-765-0517 or [email protected] if you are willing to help.
South Carolina BAR FOUNDATION
S Lawyers Sustaining Justice
50 SC Lawyer
tions, S corporation shareholders are limited to U.S. citizens and resi- dent aliens. An LLC taxed as an S corporation also faces limitations on its ownership of other entities, other than a Qualified Subchapter S Subsidiary.
2 4
Another area that favors part- nership taxation for an LLC involves distributions to the members of the LLC. There are at least four basic ways to allocate profits and losses among the owners of an entity: (1) per capita, (2) by the value of capital contributed, (3) by the value of capi- tal contributed and not yet returned, or (4) by the number of ownership units owned. An LLC taxed as a partnership can flexibly allocate profits and losses among its owners. That is, under an operat- ing agreement of the members, the entity can allocate profits and loss- es in a way that deviates from nor- mal or past profit or loss percent- ages or that is out of proportion to the owners' respective capital inter- ests.2 The flexibility as to profits has direct business advantages, allowing the entity to vary profits according to individual productivity. The flexibility as to losses can have considerable tax advantages. Of course, all of these adjustments are subject to the capital accounting rules in the Internal Revenue Code and the Treasury Regulations prom- ulgated thereunder.
LLCs taxed as S corporations lack such flexibility. Under tradi- tional corporate norms, the mem- bers receive profits per member- ship interest, and the right of each membership interest to receive dis- tributions is fixed when the mem- bership interest is created.
26
Disproportionate distributions to members of an LLC taxed as an S corporation are unlawful and run afoul of Subchapter S of the Internal Revenue Code.
Upon the liquidation, an LLC taxed as a partnership recognizes no gain, loss or depreciation recap- ture.27 A member generally recog- nizes no gain or loss upon receipt of a liquidating distribution.2 Gain is recognized by a member if the money received in liquidation is
greater than the member's basis in the LLC.29 Gain may also be realized if "hot assets" (as defined by Section 751 of the Internal Revenue Code) are disproportionately distributed.30
Loss can also be recognized only if the member's basis exceeds the money or "hot assets" received by the member.31 If other property is received by the member, no loss will be recognized. Except upon the receipt of "hot assets," the gain rec- ognized by the member will be cap- ital in character.
Upon the liquidation of an LLC taxed as an S corporation, another tax regime applies. At the entity level, an LLC taxed as an S corpora- tion may recognize significantly more income upon liquidation than an LLC taxed as partnership.
32
For example, an LLC taxed as an S corporation, unlike an LLC taxed as a partnership, is clearly subject to depreciation recapture and recap- ture of tax benefit items, whereas a proportionate liquidating distribu- tion of recapture property or tax benefit items by an LLC taxed as a partnership does not generate gain or income.
At the member level, Section 331 of the Internal Revenue Code applies. The adjusted basis of property received in liquidation by the member equals its fair market value. 33 The member recognizes gain or loss to the extent of the difference between the fair market value of the property received and the adjusted basis of the member- ship interest in the LLC taxed as an S corporation.3 4 These rules are the opposite of the nonrecognition and substituted basis rules, which generally apply to LLC or partner- ship liquidation.
Drafting the proper operating agreement
As all attorneys know, drafting an operating agreement at the out- set of forming an LLC is para- mount. A full discussion on draft- ing a proper LLC operating agree- ment is beyond the scope of this article. When electing to treat an LLC as an S corporation for tax purposes, it is important to include
the proper tax language and termi- nology in the operating agreement. To avoid confusion and unintended tax consequences, practitioners should be certain to remove lan- guage and references to partner- ship tax and Subchapter K of the Internal Revenue Code.
The partnership tax provisions should be replaced by provisions explicitly dealing with Subchapter S of the Internal Revenue Code. Specifically, operating agreements should include provisions that pro- hibit certain transfers by the mem- bers of the LLC. The transfers that all practitioners should be con- cerned about are transfers that would inadvertently terminate the S corporation election and result in the LLC being taxed as a C corpora- tion under the Internal Revenue Code. This would include a mem- ber's transfer to a partnership, cor- poration, nonresident alien individ- ual, estate (other than the estate of the member) or trust (other than a trust that, under the Internal Revenue Code, may hold S corpora- tion membership interest without terminating the S corporation elec- tion), or a tax-exempt organization (unless the tax-exempt organiza- tion may hold S corporation mem- bership interest without terminat- ing an S corporation election under the Internal Revenue Code). Furthermore, the members should not be permitted to transfer the membership interest to a person or persons that will cause the number of members to exceed 100 and ter- minate the S election. Interestingly, many of these prohibitions on transfer of a member's interest may provide for asset protection as they seemingly prohibit the fore- closure on a debtor's membership interest by prohibiting assignment to certain ineligible creditors.
Practitioners may want to con- sider having automatic buy-out provisions for members that vio- late these provisions. Practitioners should also contemplate having buy-out provisions apply to exist- ing members if they become ineli- gible "shareholders" under the S
Continued on page 58
I BINKEY AW FIMLL
1040 eWall Street Mt. Pleasant, SC 29464
Email: [email protected]
(843) 577-3092 Fax: (843) 577-3093 www.bluesteinlawoffice.com
November 2014 51
SC BAR FINANCIAL STATEMENTS Financial statements as of 6/30/14 ASSETS
Cash and Cash Equivalents-Unrestricted $ 3,511,969 Cash and Cash Equivalents-Restricted 580,921 Investments-Unrestricted 393,120 Accounts Receivable 83,740 Inventory 81,130 Prepaid Expenses and Other Assets 75,616
Total Current Assets 4,726,496 Investments-Restricted 649,161 Property and Equipment, Net 7,784,720
TOTAL ASSETS $ 13,160,377 LIABILITIES AND NET ASSETS
Current Liabilities Accounts Payable and Accrued Expenses $ 211,784 Accrued Vacation 247,475 Deterred Revenue 248,160 Current Portion ot Long-Term Debt 111,900
Total Current Liabilities 819,319 Long-Term Debt, Net of Current Portion 2,373,813
Unrestricted Net Assets Undesignated Net Assets 7,383,170 Board Designated Net Assets:
Section Funds 311,512 Lawyer Referral Service 59,293 Continuing Legal Education 737,001
Total Board Designated Net Assets 1,107,806 Total Unrestricted Net Assets $ 8,490,976
Temporarily Restricted Net Assets Grants and Other Funds 264,248 Lawyers' Fund for Client Protection 1,212,021
Total Temporarily Restricted Net Assets 1,476,269 Total Net Assets 9,967,245
TOTAL LIABILITIES AND NET ASSETS $ 13,160,377
Statement of Activities as of 6/30/14 UNRESTRICTED NET ASSETS
Revenue License and Section Fees 3,478,484 Alternative Dispute Resolution Fees 96,975 Lawyer Reterral Service Fees 341,627 Administrative Revenues 97,185 Seminars and Publications 2,437,395 Conventions 551,159 Royalties and Subscriptions 141,091 Interest and Investment Income 2,553 Other Income 63,859
TOTAL REVENUE $ 7,210,328 Expenses
General and Administrative 7,195,218 Government Relations 29,401
TOTAL EXPENSES $ 7,224,619 Funds Transferred to Temporaril Restricted 230,918 Change in Unrestricted Net Assets (245,209
TEMPORARILY RESTRICTED NET ASSETS Revenue
Grant Revenue 596,533 Disciplinary Fund 851,497 Lawyers' Fund for Client Protection Fees 614,636
TOTAL REVENUE $ 2,062,666 Funds Transferred from Unrestricted 230,918
Expenses Grant Funds 613,796 Disciplinary Fund 851,100 Lawyers' Fund tor Client Protection 763,812
TOTAL EXPENSES $ 2,228,708 Change in Temporarily Restricted Net Assets $ 64,876
Change in Net Assets (180,333) Net Assets at Beginning of Year $ 10,147,578 NET ASSETS AT END OF YEAR $ 9,967,245
52 SC Lawyer
SECTION OPERATING FUNDS Construction Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Consumer Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Corporate, Banking and Securities Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Criminal Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Dispute Resolution Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/13
Employment and Labor Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Environment and Natural Resources Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Family Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Government Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Health Care Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
$11,691.69 8,013.90 4,767.52
14,938.07
$5,370.10 2,640.00 3,113.67 4.896.43
$24,427.33 5,710.00 7,964.61
22,172.72
$26,243.57 5,550.00 8,213.24
23.580.33
$12,538.56 4,665.00 4,002.55
13,201.01
$10,380.45 7,301.76 9,320.86 8,361.35
$3,808.17 4,450.00 2,952.62 5.305.55
$26,539.81 13,057.66 23,353.34 16,244.13
$11,220.43 4,200.00 6,613.00 8,807.43
Military and Veterans' Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
$4,132.85 2,255.00 2,886.94 3,500.91
Probate, Estate Planning and Trust Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Real Estate Practice Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Solo and Small Firm Practitioners Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Tax Law Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Torts and Insurance Practices Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Trial and Appellate Advocacy Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
Workers' Compensation Fund balance on 7/1/13 YTD Revenues YTD Expenses Fund balance on 6/30/14
$5,187.16 8,640.00 9,443.73 4,383.43
$60,526.61 12,255.00 11,509.65 61,241.96
$17,193.63 14,480.00 12,148.53 19.525.10
$11,408.73 5,220.00 5,194.00
11,434.73
$44,809.50 8,870.00 4,320.76
49,358.74
$26,923.28 7,080.00 6,933.60
27.069.68
$12,360.69 6,985.00 9,563.61 9,782.08
Total Fund balance on 7/1/12 $321,426.09 YTD Revenues 125,763.32 YTD Expenses 135,677.47
Fund balance on 6/30/14 311,511.94
$6,663.53 4,420.00 3,375.24 7,708.29
November 2014 53
_
CAROLINA LAWYERS
In June the Bennett Williams Law Firm sponsored a din- ner for the HALOS Kinship
Care meeting. HALOS (Helping and Lending Outreach Support) provides assistance to abused and neglected children in Charleston County and to their caregivers. The Lambda Omicron Chapter of Delta Sigma Theta Sorority, Inc. assisted with serv- ing the meals and played games with the children. Attorney Emma Bennett-Williams is pictured sec- ond from left with members of Delta Sigma Theta. Humanity Women Build on
August 14. Priti Patel and Renee Ballew participate with the S.C. Josh Bennett is a member of
sWomenLawyers the Town TheatreBoardof Association in the Habitat for 3. Directors. He is pictured
with representatives of Central Carolina Community Foundation and Town Theatre on Midlands Gives Day, for which he coordi- nated a social media campaign that raised more than $4,000 for the theatre.
On August 26, a group vis-
ited the Homeless Court in Birmingham, AL at the
We want to hear from you! The SC Bar is proud of its lawyers, who are committed not only to their clients, but also their communities. Show us why you are proud to be a South Carolina lawyer! To be included in a future issue, send an "action" photo of your community
service or pro bono work to [email protected].
54 SC Lawyer
First Light Homeless Shelter to conduct research in a coordinat- ed effort to develop a potential Homeless Court in Columbia. Pictured from left to right: Daniel Coble, Ashley Thomas, Judge Dana Turner, Solicitor Dan Johnson, Lisa Borden, George Cauthen, Norah Rogers, Judge Donald Simons and Brandon Smith.
Warren Moise volunteers
for Big Brothers/Big Sisters. He his pictured
with his Little Brother, Zayd, as they shop for pumpkins at Boone Hall Plantation in Charleston.
.~ - ..- * - *.-. r~ r 5 r~ -- -r -
November 2014 55
