TAX 4011 FIU Preparing a Tax Memoir for Your New Client Memorandum

On the PDF file you will find the most important instruction. I also uploaded a word doc which is a sample of a tax memo. In addition you will need to use (RIA checkpoint) for some reference.   Tax 4011 Spring 2020 1201 – U02
RESEARCH MEMO
THE RULES
YOU ARE TASKED WITH PREPARING A TAX MEMO FOR YOUR NEW CLIENTS (DESCRIBED BELOW).
YOU WILL USE TURNITIN TO SUBMIT YOUR TAX MEMORANDUM. FURTHERMORE, YOU WILL USE THE
TAX RESEARCH TEMPLATE PROVIDED TO YOU IN CANVAS.
DON’T WAIT UNTIL THE LAST MINUTE OR YOUR GRADE WILL LIKELY SUFFER.
IF YOU WISH, SEND ME A DRAFT COPY PRIOR TO SUBMISSION, BUT ONLY AFTER YOU HAVE CAREFULLY
REVIEWED AND SPELL CHECKED THE PAPER. ALSO, YOU NEED TO USE A GRAMMAR CHECKER. I WILL
REVIEW YOUR DRAFT MEMO AND GIVE YOU FEEDBACK. OBVIOUSLY, IF YOU DON’T REVIEW AND RUN
YOUR PAPER THROUGH A SPELL CHECKER, AND A GRAMMAR CHECKER, I WILL NOT REVIEW YOUR
DRAFT COPY. I WANT TO REVIEW A NEAR FINAL PRODUCT NOT A ROUGH UNREVIEWED DRAFT.
YOUR MEMORANDUM SHOULD BE NO MORE THAN 5 PAGES WITH 1.5 LINE SPACING INCLUDING
REFERENCES (THE SYLLABUS INDICATES 3 PAGES OF TEXT AND THE BALANCE FOR NOTES AND
REFERENCES– I AM OK WITH YOU GOING OVER A BIT). YOU SHOULD USE COURIER OR TIMES NEW
ROMAN AND YOUR FONT SIZE NO LESS Than 10 NOR MORE THAN 12. YOUR REFERENCES CAN BE CITED
AS ENDNOTES OR FOOTNOTES. THERE IS POTENTIALLY A LOT OF INFORMATION YOU COULD PROVIDE
SO YOU WILL HAVE TO DISTILL IT DOWN WITHIN THE PAGE CONSTRAINTS.
YOU SHOULD PROVIDE A MEMORANDUM THAT IS CLEARLY WRITTEN, COHERENT, AND RELEVANT TO
THE QUESTION(S) POSED. YOU MUST USE GOOD GRAMMAR. IF YOUR GRAMMAR IS POOR OR YOUR
MEMO DISJOINTED, NOT CLEAR, OR NOT THOROUGHLY THOUGHT OUT, YOU WILL LOSE POINTS.
BECAUSE THE TOPIC IS BROAD USE YOUR EXPLANATIONS WISELY AND DON’T GET CAUGHT UP IN
GENERIC STATEMENTS. BE PRECISE AND INSIGHTFUL. USE YOUR WONDERFUL MINDS AND THINK IT
THROUGH. DO NOT REPEAT THE FACTS; I WILL ASSUME THE FACTS ARE PROVIDED. FURTHERMORE,
OTHER THAN MENTIONING THE TYPE OF ENTITY FORMED UNDER STATE STATUTE YOU SHOULD NOT
ADDRESS STATE FILING ISSUES. YOU MAY ADDRESS HOW STATE LAW TREATS THE ENTITIES FOR
LIABILITY, FORMALITY, ETC., PURPOSES.
YOU MAY GO TO THE WRITING LAB IF YOU WISH. HOWEVER, I HAVE FOUND THAT THEIR LACK OF
UNDERSTANDING OF BUSINESS AND/OR TAX CONCEPTS AND TERMS IMPEDES THEIR ABILITY TO
PROPERLY REVIEW THE PAPER FOR THIS COURSE.
YOU SHOULD DOCUMENT YOUR MEMO WITH APPROPRIATE CITATIONS TO CODE SECTIONS (IRC),
REGULATIONS (REG.), REVENUE RULINGS (REV. RUL.), REVENUE PROCEDURES (REV. PROC.), PRIVATE
LETTER RULING (PLR) QUOTES FROM RECOGNIZED TAX TREATISES (SOME CAN BE FOUND IN RIA
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CHECKPOINT’S RESEARCH MATERIALS). YOU MAY REFERENCE TAX RESEARCH TOOLS (SUCH AS RIA
CHECKPOINT), TAX TREATISES, AND TAX ARTICLES (SUCH AS FROM THE TAX ADVISOR OR THE JOURNAL
OF TAXATION).
YOU MAY NOT USE – BLOGS, TAX PREPARATION SOFTWARE BLOGS, ARTICLES ON THE INTERNET UNLESS
FROM AN AUTHORITATIVE SOURCE SUCH AS THE AICPA OR THE ABA. YOU MAY NOT USE IRS
MATERIALS UNLESS THEY ARE RELATED TO SPECIFIC LINE ITEMS ON A RETURN WITHOUT A PERTINENT
REFERENCE TO AN IRS CODE SECTION, REGULATION, REV. RUL., REV. PROC., PLR, ETC. IN THAT CASE
YOU WILL HAVE TO BRIEFLY DESCRIBE WHAT THE CODE SECTION OR REG., ETC. RELATES TO.
I AM NOT CONCERNED IF YOU QUOTE EXTENSIVELY SO LONG AS YOU CLEARLY IDENTIFY YOUR SOURCES
AND DO SO APPROPRIATELY (YOUR REFERENCES SHOULD BE PERTINENT). YOU MAY, AND PROBABLY
SHOULD, USE MICROSOFT WORD’S REFERENCES SECTION (SEE REFERENCE TAB BAR IN WORD). YOU
CAN USE THE APA STYLE. LEARN HOW TO MANAGE RESOURCES. I AM POSTING A GRAMMAR CHECKER
IN THE CONTENTS TAB THAT IS FREE TO USE AND WILL HELP SOMEWHAT. DO NOT EVEN THINK ABOUT
PLAGIARIZING. PLAGIARISM WILL RESULT IN A ZERO FOR THE ASSIGNMENT.
I AM ALSO POSTING A TAX RESEARCH TEMPLATE WHICH YOU ARE TO USE IN WRITING YOUR PAPER.
YOU WILL FIND THE TEMPLATE UNDER THE RESEARCH MEMO MODULE OF CANVAS.
I DO NOT CARE WHAT SOMEONE ELSE KNOWS, ONLY WHAT YOU KNOW AND HOW WELL YOU CAN
EXPLAIN IT. SINCE YOU ARE FREE TO QUOTE FROM PRIMARY SOURCES, TAX TREATISES AND TAX
REPORTING SERVICES (LIKE CHECKPOINT) THERE IS NO REASON NOT TO DO SO. LIKEWISE DO NOT HAVE
ANOTHER WRITE YOUR PAPER AND THEN PRESENT IT AS YOUR OWN. IF YOU DO SO YOU WILL GET AN
F FOR THE COURSE. I WILL PRETTY MUCH KNOW IF YOU HAD SOMEONE ELSE WRITE IT AND RESERVE
THE RIGHT TO REQUIRE YOU TO MEET WITH ME TO DEFEND YOUR CONCLUSIONS.
IF I INCLUDE A SECTION OF RIA OR OTHER READINGS THAT ARE ON TOPIC, I DO SO FOR A REASON –
READ IT!
BACKGROUND
Bluepoint Integrated Solutions (BIS) is a sole proprietorship owned by Mr. Foghorn Leghorn. He has an
employee, Miss Henrietta Prissy who has become an invaluable addition to his small business. He wishes
to give her an interest in the business. Henrietta is a legal resident alien of the United States. She is a
citizen of and originally from the United Kingdom.
BIS has become exceptionally profitable. It has generated net income before taxes of $750,000 last year.
Income is expected to stay the same or increase in the future.
Foghorn has come to consult with you to plan for the addition of Henrietta to his business as well
assistance with the determining the choice of the most appropriate entity type for the business (state
entity type and tax entity type. He wants to give Miss Henrietta a percentage of the profits and to give her
an ownership or a profits interest in the entity.
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Foghorn does not mind giving Henrietta an equity Interest in the business. He does not expect her to buy
her way in. She would be paid for the sweat equity (for the substantial assistance) she has provided in the
past and is expected to provide in the future.
She will get her interest on March 31, 2020. She will receive a 20% interest.
It is anticipated that all the assets (see summary balance sheet attached) of BIS (Sole Proprietorship) will
be transferred to the new entity. BIS has no liabilities.
BIS is a specified service business and all its earnings are from the material participation of the owner and
Henrietta in the business.
Foghorn has asked you the following questions (while you may wish to cover these, you may select what
you deem to be the most important one(s) or even other thoughts that you deem important:
1. “When Henrietta becomes an owner of the entity can’t I just keep on going with the entity I
have?”, If not then
2. Which type of state entity should the owners of BIS select at the time of or after Henrietta
becomes an owner?
3. Based on your answer to item 2 above, which type of tax entity would be best to select?
4. What are the tax and nontax advantages of this type of entity?
a. In your opinion, what is the most significant tax advantage of the entity you recommend
and why?
b. In your opinion, what is the most serious tax drawback of the entity you recommend and
why?
5. Why do you, the advisor, recommend this type of entity? Why do you think that this makes it a
better choice than other entity types?
6. Please describe, based on the entity that is selected what, if any tax issues will arise at the time
of entity formation for:
a. The entity
b. Foghorn
c. Henrietta
7. What will be Henrietta’s basis in the entity and what will be Foghorn’s basis in the entity after
the transaction?
8. What type of compensation or other remuneration or compensation will the owners receive from
the new entity?
9. Based on the type of entity, will all the net income be subject to employment taxes (as an
employee or self-employment as the case maybe)? If not, describe what part would be
10. Will the entity qualify for the new Qualified Business Income Deduction? If so, what are the
limitations for the entity selected? Which part?
11. Foghorn asks, “Based on the entity I select how will profits payments to us be taxed? When they
are distributed or as they are earned? If distributions are received will they be taxed? If so, how?
If not, then what will be taxed and when.
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SAMPLE MEMO
Tax Research Memo
To:
Clients
From:
SAMPLE MEMO
cc:
Professor Martin Scheckner
Date:
June 8, 2018
Re:
Advice on Forming and Structuring an Entity
INTRODUCTION: You have requested for me to advise you with respect to the tax and other
considerations in forming your proposed entity. You have also requested that I specifically
answer a number of different items which are addressed under the “Issues” section of this
memorandum.
FACTS: – see facts in separate memo
ISSUES: I will list the various issues that this tax memo will address. These include:
1. Why am I recommending this type of entity (both from a State and a Tax perspective)?
2. What are the tax consequences (positive or negative) for the entity for which I am
recommending?
a. This will include what the tax consequences are upon formation and an
explanation of a potential solution in order to reduce or eliminate the problem.
3. Will it be a problem if the individual’s ownership interests are owned by entities that they
own?
a. This will include if any additional special tax forms are required to be filed to
establish how the entity is to be taxed.
4. Who is taxed and how are they taxed during the business operation?
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a. This will include distributions of cash, property, and any other specific types of
property.
5. Who can benefit from a potential loss?
a. This will include the conditions in which losses can be claimed and what happens
to the losses that are not used.
6. What tax form is filed and what is the due date?
7. What are the tax consequences upon liquation of the owners’ interests?
8. What are the tax consequences upon liquation of the entity?
9. What are my thoughts about the new tax law (TCJA) concerning how it will affect my
recommended entity and its owners?
a. This will include provisions that are most beneficial and unfavorable to the entity
and its owners.
LAW:
There are several business organizational structures that can be formed in the State of
Florida. As the desired business will have four owners, the possible business structures that can
be formed are the following: a general partnership, a limited partnership (LP), C class
corporation, a limited liability company (LLC), and S class corporation (if applicable) (“Types of
Business Entities/Structures”). However, some business structures may contain unfavorable
outcomes if they were selected or contain requirements that prohibit it as an option in your
circumstance.
In a general partnership, according to 26 CFR § 1.752-4(c), “the amount of an
indebtedness is taken into account only once, even though a partner (in addition to the partner’s
liability for the indebtedness as a partner) may be separately liable therefore in a capacity other
than as a partner.” This may be considered unfavorable as this provides little protection to the
business’s owners because every partner in a general partnership will be held liable for any of the
business’s liabilities. As a result of this lack of protection, structuring the business in this way is
unrecommended.
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A limited partnership (LP) does contain protection against personal liabilities as a limited
partner. However, an issue arises from participation in the business as a limited partner.
According to the “Uniform Limited Partnership Act (1976) with 1985 amendments,” limited
partners are restricted in actively participating in the business. Limited partners that actively
participate will lose their protection and be treated as a general partner in the business.
Moreover, it is required that at least one owner be a general partner and be personally liable for
the debts of the business. As three of the four owners desire to actively participate in the
business, these restrictions make structuring the business as a limited partnership
unrecommended.
As we communicated prior, C corporations may be undesirable. Though this type of
business structure does protect its owners by granting them limited liability, C corporations are
subject to two levels of taxation when the business distributes its earnings through dividends.
Because of the nature of C corporations, the potential earnings for its owners are reduced as the
earnings are first taxed at the corporate level and are taxed once again when the individual
recognizes the distribution as income (26 U.S. Code § 11). As a result, while this type of
business structure does grant limited liability to its owners, it is, nonetheless, unrecommended.
Electing to be an S corporation does prevent the issue of double taxation on earnings of
the business. However, because of the strict requirements in order to elect this business
structure, this option is unavailable. Under 26 U.S. Code § 1361, a business must qualify to elect
to be an S corporation for the entire year. This issue arises as one of the individuals (Mr. Kong
Zi) has not been a U.S. resident for the entire year which has disqualified the business from
electing to be an S corporation. Although, assuming nothing of significance changes, the
business can qualify in the next year as the business will meet all the requirements.
Finally, filing an article of organization in the state and forming a limited liability
company (LLC) is advantageous as this solves much of the issues addressed above.
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CONCLUSION:
Based on this information, I recommend that the business be formed as a limited liability
company (LLC). My reasoning is that this type of business structure grants the owners with
limited liability and avoids the issue of double taxation. Additionally, unlike C corporations,
LLCs can utilize any losses that the business incurs for the year as the losses “flow through” to
its members which is typical for the first few years when starting a business. If the business
seeks to go public in the future, I would then recommend converting to a C corporation by filing
an article of incorporation (Eustice, Kuntz & Bogdansk).
For reasons mentioned above, the business cannot elect to be a S corporation this year
and as a result would have to be taxed as a partnership. However, the election can be made in
subsequent years assuming that Mr. Kong Zi remains in the United States. Among other things,
according to 26 U.S. Code § 1361, an eligible corporation must not have a nonresident alien as a
shareholder. If Mr. Kong Zi decides to return to China at a later date, the business will no longer
qualify to make the election.
The owners can also choose to wait a year to elect to be an S corporation. However, one
of the main advantages of electing to be an S corporation cannot be made. Section 351, which
enables corporations to defer any gains or losses on contributed property, is unfortunately not an
option because of Ms. Mildred Richmond-Lee. A provision under Section 351 prevents the
business from using this beneficial treatment of contributed property as services, regardless of
the timing of the services rendered, in exchange for over 20% ownership disallow the entire
business to defer any gains or loss when transferring property over to the business (26 U.S. Code
§ 351). While this might not affect Ms. Mildred Richmond-Lee too much as her services will be
taxed as ordinary income for her services rendered, this will greatly affect Mr. Alberto Nostromo
as he plans on transferring property to the business. For this reason, it may be advantageous to
continue as a partnership for tax purposes. Partnerships do not have these same restrictions
allowing for all transfers of property to be made essentially tax-free (26 U.S. Code § 721). Mr.
Alberto Nostromo will not only be able to transfer his appreciated property tax-free, but he will
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also increase his basis of the contributed property by his current debt on said property as he
remains personally liable to pay the unpaid debt (I.R.S. Publication 541).
A limited liability company taxed as a partnership must file a form 1065 tax return
annually on the 15th day of the 3rd month after year-end with a possible six-month extension to
file. There exist no restrictions on who can be a partner, such as an individual or corporations
nor are there any special filing required if an owner was a corporation, instead of an individual.
Additionally, there are few restrictions preventing a partnership to choose how to allocate
earnings to each of its partners as long as the established agreement has a substantial economic
reasoning.
Under 26 U.S. Code § 701, the partners are taxed at each owner’s individual rates and not
at the entity level. In regards to gains and/or losses on distributions to the partners, under 26
U.S. Code § 731 “Gain shall not be recognized to such partner, except to the extent that any
money distributed exceeds the adjusted basis of such partner’s interest in the partnership
immediately before the distribution, and loss shall not be recognized to such partner, except that
upon a distribution in liquidation of a partner’s interest in a partnership where no property other
than that described in subparagraph (A) or (B) is distributed to such partner, loss shall be
recognized to the extent of the excess of the adjusted basis of such partner’s interest in the
partnership over the sum of any money distributed, and the basis to the distributee, as determined
under section 732, of any unrealized receivables (as defined in section 751(c)) and inventory (as
defined in section 751(d)).” One additional note to mention concerning Mr. Robert WingbatShuthie is that because he does not plan on actively participating in the business operations, all
earnings or losses allocated to Mr. Robert Wingbat-Shuthie will be considered passive
income/loss. This is especially important to be aware of as passive losses in the business can
only be offset additional passive income. If no passive income is earning by Mr. Robert
Wingbat-Shuthie, the loss will be carried over to be used in subsequent year or lost if no
additional passive income is made (26 U.S. Code § 469).
Finally, there are a few things to note concerning the 2017 Tax Cut and Jobs Act that may
affect a new business venture. Net operating losses made by the business will no longer be
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carried back two years. Conversely, they can be carried forward indefinitely to offset up to 80%
of taxable income for a given year. This is a crucial change that can greatly increase the
business’s chances of recognizing their net operating losses in the future as it is very typical for a
business to incur losses in the first few years of operation. Unfortunately, one of the largest
changes in the tax code will have little benefit. Entities taxed as a C corporation, not as a
partnership, will have a reduced corporate tax rate (from a maximum of 35% to a flat 21%) with
their shareholders’ dividend income taxed at a preferential rate. However, flow-through entities,
such as in a limited liability company can deduct up to 20% of the business’s qualified business
income (“New Deduction for Qualified Businesses”).
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Works Cited
“26 CFR 1.752-4 – Special rules.” Cornell Law School, www.law.cornell.edu/cfr/text/26/1.7524. Accessed 23 May 2018.
“26 U.S. Code § 11 – Tax imposed.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/11. Accessed 23 May 2018.
“26 U.S. Code § 351 – Transfer to corporation controlled by transferor.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/351. Accessed 24 May 2018.
“26 U.S. Code § 469 – Passive activity losses and credits limited.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/469. Accessed 26 May 2018.
“26 U.S. Code § 701 – Partners, not partnership, subject to tax.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/701. Accessed 25 May 2018.
“26 U.S. Code § 721 – Nonrecognition of gain or loss on contribution.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/721. Accessed 24 May 2018.
“26 U.S. Code § 731 – Extent of recognition of gain or loss on distribution.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/731. Accessed 26 May 2018.
“26 U.S. Code § 1361 – S corporation defined.” Cornell Law School,
www.law.cornell.edu/uscode/text/26/1361. Accessed 23 May 2018.
Eustice, Kuntz & Bogdanski, WG&L Federal Treatise,(n.p.), (n.d.).
“New Deduction for Qualified Businesses.” IRS, 25 May 2018, www.irs.gov/newsroom/newdeduction-for-qualified-businesses. Accessed 27 May 2018.
“Publication 541 (01/2016) – Partnerships.” IRS, Jan 2016, www.irs.gov/publications/p541.
Accessed 25 May 2018.
“Type of Business Entities/Structures.” Sunbiz.org Division of Corporations, 2018,
www.dos.myflorida.com/sunbiz/start-business/corporate-structure/. Accessed 23 May
2018.
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“Uniform Limited Partnership Act (1976) with 1985 Amendments.” 11 Feb 1986,
www.uniformlaws.org/shared/docs/limited%20partnership/ulpa7685.pdf. Accessed 23
May 2018.
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2012 Comparison of Business Entities
NOTE: THESE COMPARISONS DO NOT CONSIDER STATE IMPLICATIONS.
Applicable Factor
C Corporation
S Corporation
Sole Proprietor
Partnership/Limited Liability
Partnership
Limited Liability Company
I. Formation
A. Method
Articles of Incorporation
Articles of Incorporation
None
Partnership agreement
Articles of Organization filed
in state recognizing LLCs
1. Number of
Owners
No limit
100 (Note family members
considered as one)
One
Two or more for general
partnership; one or more
general and one or more
limited for limited partnership
No limit
2. Type of Owners
No limitation
Certain individuals, estates,
charities, ESOP, trusts and S
corporations
Individual
No limitation
No limitation
3. Affiliate Limits
No limitation
Can own up to 100% of the
stock of a C corporation and
own 100% of the stock of a
qualified sub-s subsidiary. No
limitation
No limitation
No limitation
No limitation
1. Equity
No limitations (multiple
classes)
Only one class of stock (can
have voting rights differences)
N/A
No limitations (multiple
classes)
No limitations (multiple
classes)
2. Debt
No specific limits on
debts/equity ratio
Safe-harbor for debt
No specific limits
No specific limits
No specific limits
1. Election by Entity
No election requirements
Required election
No election requirements
No election requirement but
state law filing
None, unless corporate status
is elected
2. Owner Consents
None required
Consent required
None required
None required
None required
Limited to shareholder’s
capital contributions
Limited to shareholder’s
contribution
Unlimited
General partners jointly and
severally liable. Limited
partners are generally limited
to capital contributions.
Generally limited to
member’s capital
contributions.
B. Owner eligibility
C. Capital Structure
D. Status Determination
E. Liability
(check applicable
state laws)
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Applicable Factor
C Corporation
S Corporation
Sole Proprietor
Partnership/Limited Liability
Partnership
Limited Liability Company
II. Operational Phase
A. Tax Year
Any year permitted (limit for
personal service corporation)
Generally calendar year
Generally calendar year
Generally calendar year
Generally calendar year
B. Tax on Income
Corporate level
Owner level except QSST,
where paid by beneficiary.
Individual level
Owner level
Member or entity if elected
C. Elections
Corporate level
Corporate level
Individual level
Partnership level
Entity level
D. Allocation of Income/
Deductions
Not permitted (except through
multiple equity structure)
Not permitted (except through
debt/equity structure)
N/A
Permitted if substantial
economic effect
Permitted if substantial
economic effect
E. Character of Income/
Deductions
No flow-through to
shareholders
Flow-through to shareholders
Flow-through to individual
Flow-through to partners
Flow-through to members
F. Net Operating Losses
No flow-through to
shareholders
Flow-through to shareholders
(limited to basis)
Flow-through to individual
Flow-through to partners
(limited to basis)
Flow-through to members
(limited to basis)
G. Net Capital Losses
No flow-through, but five
year carryforward
Flow-through to shareholders
Flow-through to individual
Flow-through to partners
Flow-through to members
H. Effect of Statutory
Limitations
Imposed at corporate level
Imposed at shareholder level
Imposed at individual level
Imposed at partner level
Imposed at member level
A. Fringe Benefits
Shareholder-officers qualify
for benefits
Shareholder officers qualify
for benefits (medical
premiums for greater than 2%
shareholders treated like
partnership guaranteed
payments)
Generally subject to limits
applicable to individuals
Limited participation for
partners
Limited participation for
members
B. Retirement Benefits
Shareholder-officers included
in qualified plans
Certain limits on shareholderofficers
Generally subject to limits
applicable to individuals
Certain limits applicable to
partners
Certain limits applicable to
members
C. Reasonable
Compensation Limits
Applicable to shareholderofficers
Applicable to shareholderofficers
N/A
Applicable where capital is a
material factor
Applicable where capital is a
material factor
D. Payroll Taxes
Shareholder-officers subject
to payroll taxes only on
compensation
Shareholder-officers subject
to payroll taxes only on
compensation
Active owner subject to SE
taxes on all income. No
SUTA or FUTA.
Active general partner subject
to SE taxes on all income. No
SUTA or FUTA.
Active member subject to SE
taxes on all income. No
SUTA for FUTA.
III. Owner Compensation
Arrangements
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Applicable Factor
C Corporation
S Corporation
Sole Proprietor
Partnership/Limited Liability
Partnership
Limited Liability Company
IV. Transactions with Owners
A. Distributions of Cash
Dividends to extent of
earnings and profits
Dividnds, generally no effect
until the accumulated
adjustment account (AAA)
fully recovered (beware
transition rules for former C
corps)
No effect
No effect except in calculation
of basis
No effect except in
calculation of basis
B. Distribution of
Property
Dividend treatment; gain
recognition to entity
Gain recognition to entity
No effect
No gain or loss to entity
No gain or loss to entity
1. Partial Interest
Probable dividend treatment
Tax-free, but gain for
proceeds in excess of basis
Treated as sale of each asset
Capital gain treatment, except
ordinary income for ordinary
income assets.
Capital gain treatment, except
ordinary income for ordinary
income assets.
2. Entire Interest
Capital gain treatment with
exceptions
Capital gain treatment after
basis recovered
Cannot sell entity interest;
sale of business is viewed as a
sale of each asset
Capital gain treatment, except
ordinary income for ordinary
income assets and certain
§736 payments
Capital gain treatment, except
ordinary income for ordinary
income assets and certain
§736 payments
D. Property Sales to
Entity by Owner
Possible dividend treatment or
contributions to capital
Any excess value treated as
distribution or contribution
N/A
Any excess value treated as
distribution or contribution
Any excess value treated as
distribution or contribution
E. Property Sales to
Owner by Entity
Possible dividend treatment or
contributions to capital
Any excess value treated as
distribution or contribution
N/A
Any excess value treated as
distribution or contribution
Any excess value treated as
distribution or contribution
A. Sale of Interest by
Owner to Third
Person
Capital gain; no effect on
basis of corporation’s assets
(note exception § 338)
Capital gain; no effect on
basis of corporation’s assets
(note exception § 338)
Cannot sell entity interest;
sale of business is viewed as a
sale of each asset
Capital gain subject to § 751
ordinary income
categorization
Capital gain subject to § 751
ordinary income
categorization
B. Death of Owner
Estate continues as
shareholder; For basis from
decedent see Code Section
6018; no effect on basis of
corporation’s assets
Estate continues as
shareholder; For basis from
decedent see Code Section
6018; no effect on basis of
corporation’s assets
Estate takes over business
Estate as partner subject to
agreement, For basis from
decedent see Code Section
6018
Estate as member subject to
agreement, For basis from
decedent see Code Section
6018
C. Purchase of Owner’s
Interest
V. Termination of Entity or
Owner Interest
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Applicable Factor
C Corporation
S Corporation
Sole Proprietor
Partnership/Limited Liability
Partnership
Limited Liability Company
C. Liquidation
Distributions
1. Effect to
Distributor
Gain recognition if
appreciated property
distributed
Gain recognition if
appreciated property
distributed
N/A
No gain recognition on asset
distributions
No gain recognition on asset
distributions
2. Effect to Recipient
Capital gain on excess value
received over basis
Capital gain on excess value
received over basis
N/A
Substituted basis in noncash
assets equal to basis in
partnership interest
Substituted basis in noncash
assets equal to basis in LLC
interest
D. Reorganization
Tax-free to shareholders if
qualifying under
reorganization provisions
(§ 354 and § 368)
Tax-free to shareholders if
qualifying under
reorganization provisions
(§ 354 and § 368)
N/A
No taxability on merger of
partnerships
No taxability on merger of
LLC
E. Carryover of Tax
Attributes
Carryover of tax attributes to
successor entity if tax-free
reorganization
Carryover of tax attributes to
successor entity if tax-free
reorganization
N/A
N/A
N/A
Page 4 of 4
 2012 AICPA, Inc.
Page Completed 
Hi Anna – your paper requires considerable work. We will discuss this when we
speak on the phone. You did not address the issues related to taxation on entity
formation correctly. While you made some differentiations there are a number of
others.
Foghorn Leghorn
TAX 4011, 1201 U02, SPRING 2020
Tax Memorandum
Anna Hu, LLP
Miramar, Florida
1/15/2020
Relevant Facts
Foghorn Leghorn has requested recommendations as to the type of entity that Bluepoint
Integrated Solution BIS should become after Henrietta Prissy has been given an interest
(Ownership or Profits) in the business. Refer to the original inquiry for details.
Specific Issue #1
Entity classification
Prior to Prissy’s ownership, BIS was classified as a sole proprietorship. Under the terms
and conditions to qualify as a sole proprietorship, there are no set up requirements, the
sole owner has unlimited liability, and has full management control of operations. The
transfer of ownership is only allowed when all assets are transferred and there is no
transfer of a partial interest. A sole proprietorship also has no ability to raise capital.
Leghorn intends to transfer to Prissy an equity interest in the business Once Prissy
becomes an owner, the sole proprietorship will cease to exist In order to give Prissy her
20% interest, BIS would have to be either a partnership, limited partnership, limited
liability company (LLC), or corporation, or an , S corporation.
Conclusions #1
The best decision is to classify the entity as an LLC that is manager-managed for the
benefits of both parties. LLC’s can have a be single member. If so it will be a
disregarded entity and the owner will report the income.to If a LLC has two or more
members it defaults to a partnership unless a check-the-box election is made. As an
LLC taxed as a (Partnership , S??? not sure here) Leghorn can transfer equity to Prissy
while maintaining control of the company operations .
Support #1
At the time when Prissy becomes an owner, the entity can select to be a the entity
should already either have established a partnership , a limited partnership ( Limited
partnerships must file with the state) file a Certificate of Organization with the state and
1
adopt an Operating Agreement if selecting to be an LLC, or Articles of Incorporation if
filing as corporation. In addition, corporations need an incorporator, an initial
shareholder’s meeting, a board of directors, and by-laws. Filing as a corporation is
beyond the scope of this business objective therefore it will be eliminated from the
selection. If a general partnership, both parties will have unlimited liability, putting their
personal assets at stake. This is not beneficial for Prissy because she does not own a large
equity of the business but would be responsible for all the business liabilities. becoming
a limited partnership is good, but in this scenario the general partner will take the risk of
the unlimited liability of the limited partnership while the limited partner will be
subjected to lose what they invested. In my opinion An LLC would be the best choice
because if Prissy rejects the 20% interest in the form of equity, Leghorn can be a single
member LLC taxed at sole proprietorship. On the other hand, if she receives this interest,
the entity will be a two member LLC taxed at partnership or corporation. Members of
LLC also have limited liability. Their liability is limited to their required cash investment.
Specific Issue #2
Tax and nontax advantages and disadvantages
When deciding to be taxed either as a partner or corporation, it is crucial to identify the
tax and nontax advantages and disadvantages between the two.
Conclusions #2
LLC by default are taxed as a partnership/flow throw entity. In other words, income and
losses will be reported on partners personal returns. The other option is to elect to be
taxed as a corporation for income tax purposes. Under this election, the entity will be
taxed as a C class corporation which is subject to double taxation. Or if eligible can
make an election to be taxed an S class corporation, the entity avoids double taxation and
some self-employment tax.
Support #2
When doing business as an LLC taxed as a partnership, the business does not pay taxes
and the business income/loss will flow through the individuals tax return. Partnerships
are also subjected to self-employment tax of 3.8%-15.3%, and a .9% additional Medicare
tax. corporations. Conversely, corporate owners must pay tax at the entity level at a flat
21% for corporations. The shareholder then pay tax when distributions are made c (RIA
§11). Moreover, corporations are not afforded a preferential capital gains tax rate , as
are individuals . Capital losses may only be deducted to the extent of capital gains and
may not offset other income. Unused capital losses may be carried back three years and
forward five years IRC §1211(a). Flow through entities, pass through capital losses to
their owners who may be able to deduct them against their personal capital gains and an
additional $3,000. Individuals may only carry capital losses forward IRC §1211(b).
Specific Issue #3
Tax issues at the time of entity formation and ownership basis for
A) The entity
B) Leghorn
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C) Prissy
Conclusions #3
A) Must file a tax return on Form 1065 and long hours of reporting requirement
B) All the economic activities will be reported on personal tax return
C) All the economic activities will be reported on personal tax return
Support #3
An entity filing as a partnership is required to maintain partnership records. An entity
taxed as partnerships can allocate income or losses to the owners with considerable
flexibility. However, the allocations must have substantial economic effect. An LLC
offers the most choices to owners when it comes to tax and liability. From the date the
new entity is new entity has 75 days of taxable entity, the entity Afterwards, By
default the LLC will be taxed as a partnership which we believe is the preferable entity
type.
Specific Issue #4
Qualified business income deduction (QBI deduction)
Conclusions #4
Leghorn will not qualify for the qualified business income deduction but Prissy might be
able to take the QBI deduction.
Support #4
The deduction for QBI is for a qualified trade or business other than a specified service
trade or business. Pursuing to RIA §1202 and §475, a specified service trade or business
performs services in fields such as law, consulting, financial services, and any other trade
or businesses where the principle asset is the skill of its employee or owner, where it
provides investment management services, or deals in securities, partnership interest, or
commodities. In addition, QBI deductions are only allowed to taxpayers non C
corporate entities. The exception to the above rule is based on taxable income. If taxable
income is below a threshold a specified service trade or business, may qualify for the
deduction (IRC § 199A). BIS is a specified service trade or business and his allocable
share of the income will likely be above the threshold so he may not benefit from the
deduction. Ms. Prissy, may qualify for this deduction as her income is much lower.
References
3
Internal Revenue Code (RIA) ¶ D-1151 Classification of entities not subject to mandatory
corporation classification. Retrieved from
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