December 7, Tax School

Transcription

1 December 7, rd Annual Tax School State Bar of Wisconsin Taxation Law Section Tax School By Robert E. Dallman Whyte Hirschboeck Dudek S.C. 555 East Wells Street, Suite 1900 Milwaukee, WI Page 1

2 Robert E. Dallman, who serves as leader of WHD s Federal Taxation Team, has more than 25 years of federal and state tax litigation expertise either for or against the IRS and selected state taxing authorities. His practice also includes tax planning, ownership succession planning and business planning. He has been a tax attorney in private practice for more than 20 years and was previously an IRS trial attorney in Washington, D.C. and in Milwaukee. Mr. Dallman is the only actively practicing Wisconsin tax attorney who has prevailed in cases in the U.S. Tax Court, Seventh Circuit Court of Appeals, U.S. Court of Federal Claims, Wisconsin Tax Appeals Commission, and Wisconsin Circuit Court. He is also the only Wisconsin tax attorney to be invited multiple times to the U.S. Judicial Tax Conference of the Tax Court and the only Milwaukee-based tax attorney who is a member of the IRS Liaison Committee in Wisconsin. Page 2

3 Like Kind Exchanges of Partnership Interests Topics to be Addressed 1. Like Kind Exchanges (in form or in substance) of Partner Interests three alternative techniques.* 2. Sale of Personal Goodwill When Selling a Business Owned by a C Corporation. * If one or more partners/members want to disassociate with one or more of them wanting to sell their portion of the property using the tax deferred exchange rules, there are also other techniques that could be used which will not be discussed here. Examples are a promissory note technique, a special allocation technique, a swap and drop technique, or a swap and contribute technique. There are issues with respect to each of these techniques. Page 3

4 3. Installment Sales of Property with Equity Whose Mortgage is in Excess of its Basis. 4. Installment Sales of Partner Interests with a Negative Capital Account. Page 4

5 Like Kind Exchanges of Partnership Interests Disregarded Entities Introduction Page 5

6 Rev. Rul Assume a two partner partnership. 2. Buyer/Partner purchases Seller/Partner s entire interest in Seller/Buyer Partnership. Page 6

7 3. Thus, all of the partnership interests are then owned by the Buyer/Partner. 4. Buyer/Partner is treated as acquiring an undivided interest in assets in liquidation and purchasing Seller/Partner s undivided interest in assets. Page 7

8 5. Seller/Partner is treated as selling partnership interest. 6. Thus, Buyer/Partner could treat acquisition of Seller/Partner s interest as replacement property. Ltr. Rul Seller/Partner could not treat interest transferred as relinquished property. Page 8

9 Like Kind Exchanges of Partnership Interests First Technique Partnership s Sale of Relinquished Property Page 9

10 Partners Partnership Step 1: Partnership transfers relinquished property to Buyer through QI. Relinquished Property(ies) $ (sale) Q.I. (sale) Buyer Page 10

11 Like Kind Exchange of Partnership Interests (Contribution of Some Member Interests in Replacement Property LLC to Relinquished Property Partnership) Partners 40% Interest in LLC Members Partnership LLC Replacement Property Step 2: Members of Replacement Property LLC contribute 40% interest in the Replacement Property LLC to Relinquished Property Partnership in exchange for a partner interest. Page 11

12 Like Kind Exchange of Partnership Interests (Interim) Partners Members Partnership 60% 40% LLC Replacement Property Page 12

13 Like Kind Exchange of Partnership Interests (Sale/Purchase of Member Interests in Replacement Property LLC) Partners Members 60% $ Partnership 60% (sale) Q.I. Step 3: Relinquished Property Partnership buys (and historical members of the Replacement Property LLC sell) 60% interest in Replacement Property Partnership through QI using exchange proceeds. 40% LLC Replacement Property Page 13

14 Like Kind Exchange of Partnership Interests (Final Structure) Partners Members Partnership SMLLC (Replacement Property) Page 14

15 Like Kind Exchanges of Partnership Interests Second Technique (Drop and Swap) Sale of a TIC Interest by a Former Partner and Purchase of Partnership Interest by the Exchanger/Former Partner Page 15

16 Like Kind Exchange of Partnership Interests (Liquidation of Relinquished Property Partnership and Transfer to the Partners) Exchanger/ Partner Partner(s) Partnership (Relinquished Property) Step 1: Liquidation of Relinquished Property Partnership property to its partners. Page 16

17 Like Kind Exchange of Partnership Interests (Interim) Former Partner/Exchanger Former Partner(s) Relinquished Property ( TIC Interests) Page 17

18 Like Kind Exchange of Partnership Interests (Sale of TIC Interest (Relinquished Property)) TIC Owner/ Exchanger Purchaser $ TIC Interest in Relinquished Property (sale) Q.I. Step 2: Exchanger sells 100% of his/her TIC interest in Relinquished Property to the QI. Page 18

19 Like Kind Exchange of Partnership Interests (Ownership Structure of Replacement Property) Exchanger/ Partner Selling Party Member(s) Replacement Property LLC Page 19

20 Like Kind Exchange of Partnership Interests (Exchanger/Member s Purchase (through the QI) of 100% Member Interests Not Owned by the Exchanger/Member) Exchanger/ Partner/Member (sale of interests) Member(s) $ Replacement Property LLC Q.I. Step 3: Exchanger/Partner/Member s purchase of the entire member interests owned by the other member(s). Page 20

21 Like Kind Exchange of Partnership Interests (Final Structure) Exchanger/ Partner/Member SMLLC owing the Replacement Property Page 21

22 Like Kind Exchanges of Partnership Interests Third Technique Wisconsin Transfer Tax Savings Techniques (When TIC Interests are Exchanged) Page 22

23 Steps to Accomplish the Exchange 1. Steps Relating to the Relinquished Property. a) Exchanger transfers his/her 50% member interest (in the LLC (a multimember LLC) that owns the relinquished property ( Relinquished Property LLC )) to a new LLC ( NLLC, a SMLLC owned by Exchanger). Page 23

24 b) NLLC acquires its 50% TIC interest in the relinquished real estate (formerly owned by the Relinquished Property LLC) when its (i.e., NLLC s) member interest in Relinquished Property LLC is redeemed in exchange for that 50% TIC interest. c) So, at that point in time the Relinquished Property real estate is owned (as tenants in common) by Relinquished Property LLC (whose member is a SMLLC or a multi-member LLC owned by the other member(s) of Relinquished Property LLC)) and NLLC (a SMLLC owned by the Exchanger). Page 24

25 d) Exchanger sells 100% of his member interests in NLLC (a TIC interest in the relinquished property) to the buyer of the relinquished property (through a "QI"). i. Again, the sole asset of NLLC is a 50% TIC interest in the relinquished property. ii. As the NLLC is a SMLLC, it is disregarded and the Exchanger is treated as selling a TIC interest. Page 25

26 2. Steps as to the Replacement Property. a) Exchanger (who owns zero or some of the member interests in the Replacement Property LLC) buys 100% of the outstanding member interests in the Replacement Property LLC (which are not owned by him/her) from the owner(s) of those member interests. Page 26

27 i. Actually, the "QI" is the purchaser and then it (the "QI") sells the member interests to Exchanger. ii. This purchase then converts Replacement Property LLC into a SMLLC with Exchanger being the sole owner of all of the member interests of the Replacement Property LLC. Page 27

28 Diagrams for the Third Technique Potential Transfer Tax Savings Technique (Liquidation of Relinquished Property Partnership and Transfer to the Partners) Page 28

29 Like Kind Exchange of Partnership Interests (Initial Structure) Exchanger/ Partner Partner(s) Relinquished Property Partnership Page 29

30 Like Kind Exchange of Partnership Interests NLLC Exchanger/ Partner Partner(s) Relinquished Property Partnership Step 1: Exchanger/Partner assigns his/her partnership interest to NLLC (a SMLLC). Page 30

31 Like Kind Exchange of Partnership Interests (Interim Structure) Exchanger/ Partner NLLC Partner(s) Relinquished Property Partnership Page 31

32 Like Kind Exchange of Partnership Interests Step 2: Redeem the Partner interest of NLLC in the Relinquished Property Partnership in exchange for a TIC interest in the Relinquished Property. Exchanger/ Partner NLLC Relinquished Property Partnership Partner(s) Page 32

33 Like Kind Exchange of Partnership Interests (Interim Structure) Exchanger/ Partner NLLC Partner(s) Partnership Relinquished Property ( TIC interests) Page 33

34 Like Kind Exchange of Partnership Interests (Sale of TIC Interest (Relinquished Property) Via the Sale of a SMLLC Interest) Exchanger/ Member NLLC Purchaser $ TIC Interest in Relinquished Property (sale) Q.I. Step 3: Exchanger sells 100% of his/her SMLLC member interest in NLLC (which owns a TIC interest in the Relinquished Property) to the QI. Page 34

35 Like Kind Exchange of Partnership Interests (Ownership Structure of Replacement Property) Exchanger/ Partner/ Member Selling Party Member(s) Replacement Property LLC Page 35

36 Like Kind Exchange of Partnership Interests (Exchanger/Member s Purchase (through the QI) of 100% Member Interests Not Owned by the Exchanger/Member) Exchanger/ Partner/Member (sale of interests) Member(s) $ Replacement Property LLC Q.I. Step 3: Exchanger/Partner/Member s purchase of the entire member interests owned by the other member(s). Page 36

37 Like Kind Exchange of Partnership Interests (Final Structure) Exchanger/ Partner/Member SMLLC owing the Replacement Property Page 37

38 Like Kind Exchanges of Partnership Interests Concerns as to the Drop/Swap Technique (the Second and Third Techniques) 1 1. These concerns would also apply to a swap/drop transaction and a swap/contribution. Page 38

39 1. Holding Requirement a) Maybe not a problem. i. Magneson v. Commissioner, 81 T.C. 767, aff d, 753 F.2d 1490 (9 th Cir. 1985) ii. Bolker v. Commissioner, 81 T.C. 782, aff d, 760 F.2d 1039 (9 th Cir. 1985) Page 39

40 b) Maybe a problem. i. Rev. Rul , C.B. 305 (liquidation) ii. Rev. Rul , C.B. 333 (contribution) Page 40

41 Sale of Personal Goodwill 1. Applies in closely-held C Corporation situations. 2. Goal is to eliminate two levels of tax on sale of Goodwill. Page 41

42 3. Rather than the C corporation selling the Goodwill, the shareholder sells the personal Goodwill. SH cash and/or note Goodwill Buyer C corp. cash and/or note Assets Page 42

43 Cases 1. Martin Ice Cream, 110 T.C. 189 (1998). a) Taxpayer sold ice cream. Shareholder had informal oral distribution agreement/ relationship with Hagen Daz before forming corporation. b) Shareholder did not have a noncompete or employment agreement with Martin Ice Cream. Page 43

44 c) After forming the corporation, the distributor was the corporation. d) Martin formed subsidiary and distributed shares to one shareholder issue was gain on distribution of stock. e) Shareholder eventually sold distribution rights directly to Hagen Daz and corporation sold assets. IRS argued this was the value to tax on distribution of the stock. Page 44

45 f) Taxpayer prevailed in that court held the assets were personal. Tax court held lack of non-compete/employment agreement was critical in determining that goodwill/rights were individual s assets. Page 45

46 2. See also, Norwalk v. Commissioner, T.C. Memo a) Accounting firm. b) No employment agreement. Page 46

47 3. Howard v. U.S., 108 AFTR 2d (2011). a) C corporation employed a dentist who was its sole shareholder. Page 47

48 b) Dentist with an employment agreement entered into in Covenant not to compete for employment plus three years. c) He was sole shareholder; it is not clear why there was a covenant. d) In 2002, he sold business and allocated to personal goodwill. Page 48

49 e) Taxpayer argued i. Covenant was terminated when sold; ii. by law, professional goodwill was personal. f) Court disagreed citing Martin and noting that contract controlled. Page 49

50 g) Transaction recharacterized by the IRS and the court as: Step 1 Step 2 Dividend SH Goodwill Cash and/or note Buyer Distribution of Goodwill Gain on Distribution C corp. Assets Cash and/or note Page 50

51 4. Kennedy v. Commissioner, T.C. Memo a) Corporation owned an employee benefits consulting business. Negotiated sale of company. Page 51

52 b) Late in negotiations, the Taxpayer changed the structure to be sale of personal goodwill for 75% of proceeds. c) Taxpayer agreed to provide services for five years after the transaction without compensation. d) Also agreed not to compete with company. Page 52

53 e) Court held that payment was actually for services rendered and non compete. f) Distinguished Martin as saying that case did not deal with the issue of the tax to employee just that the goodwill was not the company s goodwill. Page 53

54 g) Query: i. whether some reasonable allocation to salary would have helped. h) Illustrates need for appraisal and to be involved early in process. Page 54

55 5. H&M, Inc., T.C. Memo a) Insurance agency personal goodwill. b) No employment agreement. c) Customers did not know of the corporation. Page 55

56 Take Aways 1. Address the contracts, current and old. a) In Howard, contracts were simply form agreements entered into 20 years earlier. b) If the contracts are terminated shortly before sale, IRS might view that as distribution to shareholder (per dicta in Howard). Page 56

57 2. Proceed with caution. a) Unsettled area IRS likely looking for egregious allocations (e.g., Kennedy late in negotiations, no pay for services, no appraisal, +75% allocated to personal goodwill). 3. Look at nature of company. a) Service corps (e.g., accounting firms) more likely to have personal goodwill. Page 57

58 4. Consider appraisal and allocate some intangibles (i.e., corporate goodwill) to company. 5. Use separate agreements for shareholder and company. 6. Advise clients not to use C corporations or consider S election for existing C corporations. Page 58

59 7. If representing buyer, a) do not buy the stock and the personal goodwill; buy assets and goodwill. Page 59

60 Installment Sales of Property with Equity Whose Mortgage Is In Excess Of Its Basis 1. General Rule. a) Excess of mortgage over the basis of the property is deemed to be a payment in the year of closing. Page 60

61 2. Wraparound land contract. a) Stonecrest, 24 T.C. 659 (1955); AOD, 1974 WL b) If the form is respected, excess of mortgage over the basis of the property is not deemed to be a payment in the year of closing. Page 61

62 3. But cf. Kline, T.C. Memo ; Waldrep, 428 F.2d 1216 (5 th Cir. 1970); Voight, 68 T.C. 99 (1977); Goodman, 74 T.C. 684 (1980); Hutchinson, T.C. Memo all based on different facts with the cases not rejecting the teaching of Stonecrest. Page 62

63 Installment Sales of Partner Interests With A Negative Capital Account 1. General rules. a) Code section 731: Money distributed in excess of a partner s outside basis is taxable subject to sections 741 and 751. a) Code section 752(b): A decrease in a partner s share of his/her liabilities is a deemed distribution of money. Page 63

64 2. A negative capital infers that the partnership owns property with a mortgage in excess of the partnership s basis in the property. Page 64

65 3. Planning point. a) Sell partner/member interest and expressly continue to be personally obligated (without subrogation or indemnification) on the partnership/llc debt to an amount equal to the negative capital account. Page 65