How is a Profits Interest in an LLC Taxed?

If I am given a profits interest in a partnership or limited liability company, how am I taxed?  It is relatively common for an LLC (for purposes of this article, a partnership and LLC may be considered the same type of business) to give an interest to a service provider.  The taxation of the interest is different depending upon the type of interest as a capital interest can be different than a profits interest.  The article below discusses a profits interest.  A profit’s interest is a type of equity in the applicable business, and is designed to give the individual a predetermined share of future growth in the value of the business.  A profits interest can be differentiated from a grant of stock within a corporation because the profits interest would not entitle the holder of the profits interest to share in the businesses current value.  Rather the profits interest provides for a share of future profits and appreciation within the business, as opposed to an interest or share in the company’s current value.  This position, is what dictates the tax treatment of a profits interest when provided to the holder of the interest.

 

Initially, courts appeared to have mixed feelings regarding the taxation of a profits interest.  In 1974, a federal court of appeals held that the receipt of the profits interest should be considered taxable income when the interest had a readily determinable market value.  However, later another federal court made a determination that would appear to suggest the service provider receiving a profits interest and acting as a partner within the company could receive the interest without the interest being taxed upon receipt.

 

Revenue Procedure 93-27 was issued by the Internal Revenue Service in 1993 to provide guidance regarding the taxation and treatment of a profit’s interest in a partnership.  The Internal Revenue Service used a hypothetical liquidation test in the Revenue Procedure 93-27 analysis.  Under the hypothetical liquidation analysis, a liquidation would not give the profits interest holder a share of the partnership assets if the partnership liquidated all assets and distributed cash to the partners.  In terms of the timing of the liquidation, the liquidation is deemed to occur at the time of the partner receives the profits interest, and thus there would have been no real increase in the value of the business from the time of receipt to the time of the deemed liquidation.  This analysis entitles the holder of the profits interest only to a share of future profits and appreciation in the business, rather than an immediate interest in the partnership’s current value.  Thus, when a partner receives a profits interest for services, or for the benefit of the partnership in a partner capacity, or even in anticipation of being a partner, the IRS will likely not treat the receipt of the interest as a taxable event.  It is important to note that the IRS may not treat the receipt of a partnership interest as a non-taxable event if in fact the profits interest would bring about a substantially certain and predictable amount of income to the recipient.

 

The article above has been prepared by John McGuire of the McGuire Law Firm.  As a tax attorney and business attorney, John’s practice focuses primarily on taxation issues and business transactions.

Denver Tax Attorney

Denver Tax Attorney

Is Your Business a Hobby?

Is your business considered a hobby by the Internal Revenue Service?  One of the key questions or issues is whether or not your business is an activity engaged in for profit.  While you may feel your business is established and engaged in for a profit, the IRS may feel otherwise, and the Internal Revenue Code can impact your deductions.  This article has been prepared by a tax attorney to provide additional information regarding this issue.  Please consult with your tax advisors or tax attorney regarding any questions you have.

The pertinent section relating to activities engaged in for profit is section 183, which is often referred to as the “Hobby Loss Rule.”  IRC Section 183 limits deductions that a business may anticipate they can claim when the business is not engaged for a profit.  As a business owner you can deduct ordinary and business expenses when conducting your business activity.  However, if your business activity is deemed to not be engaged in for the production of income (a profit), you may not be able to deduct some or all of the expenses.

The IRS will consider certain facts and circumstances when determining whether your activity or business is a hobby, or an activity engaged in for profit. Some of these issues are stated below.

 

  • Do you depend upon the income? Do you rely upon the activity or business to provide income that supports you?
  • What amount of effort and time do you put into the activity, and does the amount of time and effort show you intended to make a profit?
  • What is your knowledge base in regards to the activity and does such knowledge provide you with the ability to make a profit?
  • Have you been successful in making a profit with the applicable activity or a like activity in the past?
  • Has the activity made a profit in some of the taxable periods?
  • What actions or methods have you implemented to improve profit or allow the activity to be profitable?
  • If the activity has sustained losses, are the losses explained by circumstances beyond the taxpayer’s control?
  • If the activity has sustained losses, are the losses due to reasonable or anticipated start up expenses?

 

If an activity makes a profit in at least three of the last five years, then the IRS should validate the business as an activity engaged in for profit.  If the activity is deemed a hobby (not for profit), the losses from the activity cannot be used to offset other income.  In short, the activity cannot produce a loss.  Thus, the allowable deductions and expenses for the activity cannot exceed the gross income (gross receipts) of the activity.

If you have questions related to your business income, deductions and related matters, speak with a tax attorney at The McGuire Law Firm.  Free consultation with a tax attorney in Denver or Golden Colorado.

IRS Lien Release With Offer in Compromise Acceptance

A Notice of Federal Tax Lien can provide a number of problems for a taxpayer.  Recently, the IRS has been releasing the Notice of Federal Tax Lien when a taxpayer successfully has an offer in compromise accepted by the IRS and pays the offer amount.  This is a wonderful benefit to the taxpayer as the IRS did not always release the tax lien upon payment of the settlement amount, but rather would wait for the five-year compliance period after the offer has been accepted.

The video below has been prepared by a tax attorney at The McGuire Law Firm to provide additional information regarding this issue.  If you have any type of tax issues with the Internal Revenue Service, contact The McGuire Law Firm to speak with a tax attorney.

Funding a Buy Sell Agreement

When business partners enter into a buy sell agreement, one of the pertinent issues or items for the partners to discuss is how the buy-out will be funded. The purchasing business entity or purchasing party can obtain the funds to purchase business interests from a variety of sources, which are discussed below.

The purchaser always has the ability of self-funding the purchase.  If the purchaser does not have the required cash to purchase the interest, issues may arise whereby the seller will request some type of security interest.  Furthermore, if the purchaser lacks the cash to purchase the interest in full and equity in assets to fully secure the seller, a seller may request the buyer obtain a life insurance policy whereby the seller or the seller’s designee is the beneficiary of the policy until the purchase terms have been complied with.

Apart from a self-funded purchase, the most common source of funds for a buy-sell agreement is insurance.  Multiple types of insurance such as life insurance or disability insurance could be used to fund the buyout of the seller’s interest.  Where the triggering event for the purchase of the applicable interest is death, life insurance on the individual can be a very clean means by which to fund the purchase.  However, what if a disability or the retirement of an individual leads to the need to purchase such individual’s ownership interest?  Under these circumstances, life insurance may not be very useful as a source for funds.  To be useful as a source of funds for a buyout, a life insurance policy may need a significant cash value.

When the buy-sell agreement is between the owners of the business, it will likely be necessary for each owner to carry insurance on the life of each of the fellow business owners.  Therefore, multiple policies may be needed if each owner is separately insured.  Further, consider how many policies may be needed if there were say 8 different partners or business owners? If a redemption agreement is used, the owners do not insure the lives of the other owners, but rather, the business must purchase a joint-life policy or separately insure the life of each owner who the business has the obligation to redeem.

The types of life insurance policies could include term life insurance, cash value life insurance, whole life insurance, universal life insurance and survivor joint life insurance.  In regards to the need to purchase an owners interest because of a disability, the owners should consider disability insurance.  In many respects, it may be more likely for a business owner to be disabled than pass away during a time in their life when they still own the business interests and thus a purchase would be necessary.  Therefore, business owners should consider the need for disability insurance to fund a buyout, in addition to having life insurance available.

This article was written by John McGuire, a business attorney and tax attorney at The McGuire Law Firm in Denver, Colorado. Please remember this article was prepared for informational purposes and you should always speak with a business attorney or other counsel to discuss your specific issues & circumstances.

Denver Business Attorney

 

 

Valuing Real Estate for an Offer in Compromise

When calculating an offer in compromise amount, one of the biggest issues is a taxpayer’s equity in assets.  If a taxpayer owns a home the equity in the home will need to be accounted for calculating the offer amount.  This brings about the pivotal question, how is real property or a home valued for the purposes of an offer in compromise with the IRS?  Unlike a bank account, stocks, bonds or other account with an easily ascertained fair market value, the value of land and/or a home is more subjective and at issue.

That being said, recently our position has to been to value the home at the most recently assessed tax assessment from the county.  Generally speaking, the Internal Revenue Service has agreed with this valuation.  If a taxpayer thinks the value of their home is less than the tax assessed value, you will want a formal appraisal conducted and you will need to show why the value is less than the tax assessed value.

If you have any questions related to a tax settlement or offer in compromise, please contact The McGuire Law Firm to speak with a tax attorney.  We offer a free consultation with a tax attorney to all potential clients.

Denver Tax Attorney

IRS Form 14654

IRS Form 14654 is used when submitting documents for the Streamlined Offshore Voluntary Disclosure Program.  The video below has been prepared by a tax attorney at The McGuire Law Firm to provide additional information regarding the Form.  You can contact The McGuire Law Firm to speak with a tax attorney regarding your tax matters, including foreign tax accounts and assets.

Depreciation and Impact on Basis

When an asset is placed into service and depreciation is taken as a deduction, the adjusted basis of the asset will be impacted.  The video below has been prepared by a tax attorney at The McGuire Law Firm to discuss this issue.  Please remember to always consult your tax attorney, business attorney, CPA and/or other advisers regarding your specific facts and circumstances.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm.  You can contact John at 720-833-7705 or via the website at: https://jmtaxlaw.com/contact-us/

 

What is a 401(k) Deferral?

Contributions to a 401(k) are qualified deferrals.  This means that the amount should not be included in your income when calculating income tax.  You can check your W-2 and the amount of taxable wage should not include the 401(k) contributions.  The video below has been prepared by a tax attorney at The McGuire Law Firm to provide additional information regarding this matter.

Common Capital Contributions to a Partnership

When forming a partnership the partners will make initial capital contributions and may make additional contributions depending upon the operations of the partnership and partnership agreement.  Common capital contributions may include cash, property (vehicles, equipment, computers etc.) and sometimes services.

The video below has been prepared by a tax attorney and business attorney at The McGuire Law Firm to discuss capital contributions.

John R. McGuire is tax attorney and business attorney at The McGuire Law Firm.  The McGuire Law Firm represents and advises clients on tax matters from IRS debts and tax audits or overall tax planning and the tax implications of certain transactions.  Further, the firm represents small and medium sized business with their contract issues as well as the formation and sale of businesses or business interests.  In addition to his law degree, John holds an advanced degree in taxation known as an LL.M.  The McGuire LAw Firm provides a free consultation with a tax attorney.

Deducting Business Expenses

Can I deduct my meals as a business expense?  Can I deduct this flight as a business expense?  Can I deduct the cost of my clothes or uniform as a business expense?  As a tax attorney, these are common questions I am asked, and rightfully so as everyone wants to take advantage of all potential deductions allowed by the Internal Revenue Code.  Not only is the deductibility of certain business expenses a hot topic with business owners, it is a hot topic and highly litigated topic with the Internal Revenue Service.  In fact, I recall reading a recent annual report to Congress by the Taxpayer Advocate Service whereby the deductibility of trade or business expenses he been one of the top ten most litigates issues for a very long time.  Furthermore, the same report stated that the courts affirmed the position taken by the Internal Revenue Service (the dissallowance 0f the deduction) in the vast majority of cases and that the taxpayer only prevailed (in full) about two-percent (2%) of the time.  The article below is not intended to be legal advice, but rather to provide general information regarding this issue.

First and foremost, we should start with the current law regarding deductions for business expenses.  Internal Revenue Code (the “Code”) Section 162 allows deductions for ordinary and necessary expenses incurred in a business or trade.  What actually constitutes ordinary and necessary may better be understood through an analysis of the case law, which is significant, surrounding the question.  Generally, the determination is made based upon a court’s full review of all facts and circumstances.

Based upon the black and white law under the Code, what constitutes a trade or business for purposes of Section 162.  Perhaps it is ironic that the term “trade or business” is so widely used in the Code, but yet, neither the Code nor the Treasury Regulations provide a definition for Trade or Business.  Personally, I think it would be quite hard to provide a definition for trade or business, especially under the auspices of income tax.  The concept of trade or business has been refined and defined by the courts more so than the Code.  The United States Supreme Court has held and stated that a trade or business is an activity conducted with continuity and regularity, and with the primary purpose of earning a profit.  Albeit broad, I would agree this definition would be sufficient for the majority of businesses I work and assist.

Now that we have an idea of what may constitute a trade or business, what is “ordinary and necessary?”  Again, the Supreme Court has helped provide definitions for these broad, but important terms.  Ordinary has been defined as customary or usual and of common or frequent occurrence in the trade or business.  Necessary has been defined as an expenses that is appropriate and helpful for the development of the business.  Further, it should be noted that some courts have also applied a level of reasonableness to each expense.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm focusing his practice on issues before the IRS, tax planning & analysis and business transactions from formation to sale.

Denver Tax Attorney