|Section of Taxation|
The Tax Lawyer vol. 52 no. 1 Fall 1998
The Tax Lawyer
|THE TAX LAWYER|
Recent business developments, i.e., the creation of the LLC, and tax developments, i.e., the optional tax classification for an unincorporated entity, have made it easier to choose an appropriate entity. This Article analyzes the choice of entity issue in light of these developments, focusing primarily on the entity choices presented to individuals who participate in a business as owners, rather than as creditors or employees. This Article examines the central distinction in the Code between C corporations and pass-through entities, identifies the circumstances in which one should be preferred to the other, and analyzes the differences among the available forms of pass-through entities that govern the choice of entity decision once the use of a C corporation has been ruled out. The authors conclude that what used to be a difficult choice should now be recognized as an obvious one. That is, if pass-through treatment is desired and available, the choice of entity involves selecting the best available pass-through entity from a hierarchy of entities, the clear leader of which is the state law LLC treated as a pass-through entity for federal tax purposes.
This article demonstrates that: (1) pass-through treatment is economically preferable to taxation as a C corporation in most cases; (2) in the case of any new business other than one formed or likely to be publicly-traded, a state law LLC taxed federally as a pass-through is the entity of choice unless state law precludes its use, in which case an S corporation is at the top of the list of alternatives; (3) in the case of an existing C corporation or new business that is, or is likely to be, publicly-traded, there is no choice other than a C corporation because pass-through status is almost certainly unavailable; and (4) in the case of any existing C corporation that is not publicly-traded, conversion to an LLC is optimum, but if the tax cost of liquidation is prohibitive, S status is the only choice. This Article then tests these conclusions in light of the choice among forms of business enterprise available for the practice of law.
The Article ends with an analysis of major secondary issues—problems of converting from one entity to another and continuing disparities between the federal and state tax treatment of LLCs—and a call to lawyers to recognize the LLC as the entity of choice for the next millennium.
As a result of the general rule of section 743(a), under which a partnership’s basis in its assets (inside basis) is unaffected by the purchase of a partnership interest, a purchasing partner’s share of gain or loss recognized on the subsequent sale of partnership assets or the amount of depreciation allowable with respect to those assets will not properly reflect the purchasing partner’s outside basis. If, however, the partnership makes a section 754 election, section 743(b) allow an adjustment to inside basis with respect to the purchasing partner. Section 755 provides the rules for allocating the basis adjustment among the partnership’s assets. Both the determination of the amount of the aggregate section 743(b) basis adjustment and the allocation of that basis adjustment among the partnership’s assets can be complex, and resort must be made to the Treasury Regulations for detailed requirements governing the computations. The current Treasury Regulations governing these issues are incomplete and, in part, inconsistent with the theoretical rationale for the basis adjustment provisions. Recently, however, the Treasury Department has issued Proposed Regulations that would substantially revise and clarify the methodology for determining both the aggregate section 743(b) basis adjustment and the method for allocating that adjustment among the partnership’s assets. Those Proposed Regulations are the primary subject of this article.
This article focuses on the major federal income tax issues related to the costs imposed on U.S. businesses by federal environmental regulation. Manufacturing concerns, real estate developers, and even passive investors in real estate syndications can themselves face potential liabilities and, ultimately, be required to expend significant sums to comply with the environmental statutes. This article evaluates the tax implications flowing from the most common and important transactions required or mandated under these laws. The environmental statutes have a substantial impact upon ongoing business operations (e.g., the establishment of emission controls, permitting, the development of waste management requirements, expenditures on new technology to reduce emissions, etc.). This form of regulation imposes substantial compliance cost on businesses. Environmental remediation costs are incurred where there are unpermitted discharges of contaminants into the environment (e.g., hazardous waste cleanups, soil and water remediation, wetlands restoration, etc.). These include cleanup operations required where hazardous materials have been "dumped" illegally – or, in certain cases, before the dumping became illegal. Together, expenditures for environmental compliance and remediation are the costs that result from environmental transactions.
For the most common environmental transactions imposed by statute or regulation, this article identifies the relevant tax issues, considers the appropriate tax treatment, and discusses various planning opportunities frequently overlooked. Tax professionals and legal advisers representing businesses in environmental transactions (as well as in litigation arising out of such transactions) must be aware of the various tax issues and the potential impact on their clients. Rather than an after-thought, tax issues should be a driving factor from the very first stage of the environmental transaction.
This article analyzes and critiques the operation, effectiveness, and constitutionality of the notice requirements that Congress mandated as an integral component of the special audit rules for partnerships ("Partnership Audit Rules"). Congress adopted the Partnership Audit Rules in part to cure the administrative difficulties endemic to a system in which the Service had to audit each partner in a large investment partnership separately. The new regime centralizes the audit process at the partnership level and is based on the central tenet that one specially-assigned partner will effectively coordinate and manage these proceedings on behalf of the other partners, thereby reducing the need for individual participation by (and individual notice to) the other partners. The law of agency and state partnership statutes embody similar principles