aSelected Tax Developments
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Denver, CO 80202 303-295-8000
Chicago, IL 60603 312-845-3760
A. Codification of Economic Substance Doctrine ....................................................................2
B. Developments in the Treatment of LLCs as Partnerships and Disregarded Entities ............3
1. Disguised Sales (707(a)(2)(B)) .........................................................................................5
3. Explanation of Provisions ...............................................................................................11
II. Employment Tax Update ...........................................................................................................14
1. 2010.................................................................................................................................14
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A. Codification of Economic Substance Doctrine
Under new legislation intended to help pay for the health-care law,1 taxpayers are now subject to a 40% penalty on underpayments of tax attributable to transactions that lack economic substance as defined under new section 7701(o) of the Internal Revenue Code or fail to meet the requirements of any similar rule of law. This penalty will be reduced to 20% if the relevant facts affecting the tax treatment are disclosed in the taxpayer’s return.2 Significantly—and this may be the most striking aspect of the new legislation—there is no reasonable-cause defense.3 Thus, a taxpayer who derives tax benefits from a transaction determined to lack economic substance will be subject to the 40%/20% penalty even if the taxpayer acted reasonably and in good faith. Opinions of outside counsel or in-house tax analyses will not protect a taxpayer from imposition of the penalty. These new rules apply to transactions entered into after March 30, 2010.
New section 7701(o) provides that, in the case of a transaction to which the economic- substance doctrine is relevant, the transaction will be considered to have economic substance only if both—
it changes the taxpayer’s economic position (apart from federal income tax benefits) in a meaningful way, and
the taxpayer has a substantial purpose (apart from the federal income tax effects) for entering into the transaction.
These rules do not specify the transactions to which the economic-substance doctrine is relevant. Thus, whether the relevancy precondition is met is presumably left to the discretion of the IRS and, ultimately, the courts.
A taxpayer may rely on a transaction’s profit potential to show that a transaction has economic substance only if the present value of the reasonably expected pre-tax profit is substantial in relation to the present value of the expected net tax benefits.4 The provision does not require or establish a minimum return that will satisfy the profit-potential test. Notice 2010-62 (2010-40 IRB 1) provides that in applying this calculation, the IRS will apply existing relevant case law and other published guidance. Fees and other transaction expenses are taken into account as expenses in determining pre-tax profit. Treasury has been tasked with issuing regulations treating foreign taxes as an expense in determining pre-tax profit in appropriate cases. Notice 2010-62 provides that in the interim, the enactment of the 7701(o) does not restrict courts from considering the appropriate treatment of foreign 1 H.R. 4872, Health Care and Education Reconciliation Act of 2010. 2 See Internal Revenue Code § 6662(b)(6), (i). 3 See id. § 6664(c)(2). 4 See id. § 7701(o)(2).
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taxes in economic substance cases.
In the case of individuals, new section 7701(o) applies only to transactions entered into in connection with a trade or business or activities engaged in for the production of income. It therefore appears that routine charitable giving and estate planning will not be subject to the new economic-substance test.
The new law also modifies section 6676 of the Code, relating to erroneous claims for refunds or credits. Under section 6676, a taxpayer that claims a refund or credit without a “reasonable basis” for the claim is subject to a 20% penalty on the amount by which the amount of the claim exceeds the amount of the claim allowable for the year. New section 6676(c) provides that a taxpayer will not be considered to have a reasonable basis for any claim for such excess amount if the excess amount is attributable to a transaction that lacks economic substance under new section 7701(o) or fails to meet the requirements of any similar rule of law.
The new law is not intended to disallow tax benefits that are consistent with the congressional purpose or plan that the benefits were designed to effectuate. Nor is it intended to alter the tax treatment of certain basic business transactions that, under longstanding judicial and administrative practice are respected, merely because the choice between meaningful economic alternatives is largely or entirely based on comparative tax advantages. Among these are (i) the choice between capitalizing a business enterprise with debt or equity, (ii) a U.S. person’s choice between using a foreign corporation or a domestic corporation to make a foreign investment, (iii) the choice to enter into a transaction or series of transactions that constitute a corporate organization or reorganization, and (iv) the choice to use a related-party entity in a transaction, provided the parties act consistently with arm’s-length standards.
Despite these assurances, however, there are a number of normal-course business transactions that could be considered to lack economic substance under new section 7701(o) if the economic-substance doctrine were considered relevant to those transactions. Thus, while the new rules clearly reach abusive tax shelters, depending on how the rules are applied, they may also extend to a wide range of business transactions that have not historically been targeted by the IRS as lacking economic substance. Given this, and the fact that the potential penalties are so harsh (i.e., automatic 40%/20% penalties with no reasonable-cause exception), taxpayers should carefully evaluate the risk that contemplated transactions may be subject to these rules.
In Notice 2010-62, 2010-40 IRB 1, the IRS’s took a first step (albeit a very small one) toward providing taxpayers the badly needed guidance as to the application of the codification of economic substance. The Notice confirms that the IRS will continue to rely on relevant case law under the common-law economic substance doctrine in applying the two-prong conjunctive test in section 7701(0)(1). As such, Notice 2010-52 confirms (not surprisingly), that the IRS will apply common law economic substance case law pertaining to whether the tax benefits of a transaction are not allowable because the transaction does not satisfy (x) the economic substance prong and (y) the business purpose prong. The Notice also confirms that the IRS will challenge taxpayers who seek to rely on prior case law under pre-7701(o) case law for the proposition that the disjunctive, rather than
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conjunctive, test of economic substance applies. The Notice states:
[T]he IRS will continue to analyze when the economic substance doctrine will apply in the same fashion as it did prior to the enactment of section 7701(o). If authorities prior to the enactment of section 7701(o), provided that the economic substance doctrine was not relevant to whether certain tax benefits are allowable, the IRS will continue to take the position that the economic substance doctrine is not relevant to whether those tax benefits are allowable. The IRS anticipates that the case law regarding the circumstances in which the economic substance doctrine is relevant will continue to develop. Consistent with section 7701(o)(5)(C), codification of the economic substance doctrine would not affect the ongoing development of authorities on this issue. The Treasury Department and the IRS do not intend to issue general administrative guidance regarding the types of transactions to which the economic substance doctrine either applies or does not apply.
The Notice also provides the following guidance with respect to penalties:
Unless the transaction is a reportable transaction, as defined in Treas. Reg. Section 1.6011-4(b), the adequate disclosure requirements of section 6662(i) will be satisfied if a taxpayer adequately discloses on a timely filed original return (determined with regard to extensions) or a qualified amended return (as defined under Treas. Reg. Section 1.6664-2(c)(3)) the relevant facts affecting the tax treatment of the transaction. If a disclosure would be considered adequate for purposes of Section 6662(d)(2)(B) (without regard to section 6662(d)(2)(C) prior to the enactment of section 1409 of the Act, then it will be deemed to be adequate for purposes of section 6662(i). The disclosure will be considered adequate only if it is made on a Form 8275 or 8275-R, or as otherwise prescribed in forms, publications, or other guidance subsequently published by the IRS consistent with the instructions and other guidance associated with those subsequent forms, publications, or other guidance. Disclosures made consistent with the terms of Rev. Proc. 94-69 also will be taken into account for purposes of section 6662(i). If a transaction lacking economic substance is a reportable transaction, as defined in Treas. Reg. Section 1.6011-4(b), the adequate disclosure requirement under section 6662(i)(2) will be satisfied only if the taxpayer meets the disclosure requirements under section 6011 regulations. Similarly, a taxpayer will not met the disclosure requirements for a reportable transaction under the 6011 regulations by only attaching Form 8275 or 8275-R to an original or qualified amended return.
B. Developments in the Treatment of LLCs as Partnerships and Disregarded
Entities 1. Disguised Sales (707(a)(2)(B)) and Economic Substance Doctrine
a. U.S. District Court of New Jersey applies substance over form analysis to recast purported capital contribution of assets to partnership and transfer of loan proceeds to transferring partner as a disguised sale under IRC § 707(a)(2)(B). In re G-I Holdings, Inc., 105 AFTR 2d 2010-697 (Dec. 14, 2009). After applying a Culbertson analysis to
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concluded that the relationship of the parties constituted a partnership for federal income tax purposes, the Court concluded that the substance of the transactions at issue produced tax results inconsistent with their form in the underlying document. The Court held that, as a matter of substance, the taxpayer’s transfer of $480 million in assets to the partnership are properly viewed as a direct transfer of money or other property by a partner to a partnership within the meaning of IRC § 707(a)(2)(B)(i). The Court further found that loan proceeds of $460 million, paid by a bank to such transferring partner on the same date, constituted an indirect transfer of money or other property by the partnership to a partner within the meaning of IRC § 707(a)(2)(B)(ii). The Court found that the bank payment was structured to function as a payment to such partner in substance, and that when viewed together, the transfers to the partnership and the payment to the partner, are properly characterized as a sale of property pursuant to IRC § 707(a)(2)(B)(iii).
b. U.S. Tax Court recasts capital contribution of assets to partnership and transfer of loan proceeds to transferring partner as a disguised sale under IRC § 707(a)(2)(B). Canal Corp. v. Commissioner, 135 T.C. No. 9, No. 14090-06 (August 5, 2010). W, a wholly owned subsidiary of parent, P, proposed to transfer its assets and most of its liabilities to a newly formed LLC in which W and GP, an unrelated corporation, would have ownership interests. P hired S, an investment bank, and PWC, an accounting firm, to advise it on structuring the transaction with GP. P also asked PWC to issue an opinion on the tax consequences of the transaction and conditioned the closing on receiving a “should” opinion from PWC that the transaction qualified as tax free. PWC issued an opinion that the transaction should not be treated as a taxable sale but rather as a tax free contribution of property to a partnership. W contributed approximately two-thirds of the LLC’s total assets in 1999 in exchange for a 5% interest in the LLC and a special distribution of cash. W used a portion of the cash to make a loan to P in return for a note from P. After the transaction, W’s only assets were its LLC interest, the note from P and a corporate jet. The LLC obtained the funds for the cash distribution by receiving a bank loan. GP guaranteed the LLC’s obligation to repay the loan. W
Preferred distributions tied to debt service
$
$480M appreciated assets
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agreed to indemnify GP if GP were called on to pay the principal of the bank loan pursuant to its guaranty. The LLC thereafter borrowed funds from a financial subsidiary of GP to retire the bank loan. GP entered into a separate transaction in 2001 that required it to divest its entire interest in the LLC for antitrust purposes. W subsequently sold its LLC interest to GP, and GP then sold the entire interest in the LLC to an unrelated party. P reported gain from the sale on its consolidated Federal income tax return for 2001. The IRS determined that P should have reported a gain when W contributed its assets to the LLC in 1999. The IRS has also asserted a substantial understatement penalty under IRC § 6662(a) against P. Loan was guaranteed by GP. W agreed to indemnify GP if GP were called upon to pay the bank loan.
Held: W’s asset transfer to the LLC was a disguised sale under IRC § 707(a)(2)(B). P must include gain from the sale on its consolidated Federal income tax return for 1999.
Held, further, P is liable for an accuracy-related penalty for a substantial understatement of income tax under IRC § 6662(a).
c. Va. Hist. Tax Cred. Fund 2001 LP v. Commissioner, T.C. Memo. 2009-295. Investors in partnership formed for the purpose of allocating state tax credits to the Investors were in fact partners in the partnership.
In Va. Hist. Tax Cred. Fund 2001 LP v. Commissioner, T.C. Memo. 2009-295, the taxpayers became partners of certain partnerships for the purpose of participating in a Virginia state tax credit program. The program allowed Virginia historic rehabilitation income tax credits
* Large accounting firm rendered “should” opinion that the $755M distribution not taxable.
$151M Note = 20% of Bank debt
5%
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to be allocated to partners disproportionate to the partnership’s allocation of profits and losses. Under the partnership agreements, certain partners (the “Investors”) with small interests in partnership profits and losses were allocated large shares of the state tax credits. The IRS asserted that the partnerships were in substance selling tax credits and had failed to report the gain from these alleged sales. The IRS’s first argument in support of its position was that the Investors were not partners for federal tax purposes, thus the contributions of capital and the allocation of tax credits, was in substance a sale of the tax credits.
With regard to the first IRS argument, the court reviewed the evidence of the partners’ intent with respect to the partnerships and whether the partners had a valid business purpose. In analyzing whether the Investors were partners, the court relied on Culbertson v. Commissioner, 337 U.S. 733 (1949) and Commissioner v. Tower, 327 U.S. 280 (1946). Under Culbertson and Tower, in order to determine if a partnership exists, the court must determine whether the parties intended to join together in good faith with a valid business purpose. In finding that the Investors intended to become partners in the partnerships, the court reviewed the agreements among the partners, the conduct of the parties in executing the agreements, the trial testimony of the parties and of disinterested professionals, and the relationship of the parties including their respective abilities and capital contributions.
In examining the business purpose of the transaction, the court stated that “[t]he form of a transaction will not be given effect where it has no business purpose or operates simply as a device to conceal the true character of a transaction. See Gregory v. Helvering, 293 U.S. 465, 469-470 (1935).” The IRS position was that the transaction lacked a business purpose because the Investors did not make their contributions in anticipation of receiving profits from the partnership, but instead were only interested in receiving state tax credits. The court held that the Investors had a business purpose because of the considerable economic benefit they would receive from state tax savings. The court reasoned that purpose of reducing non-federal taxes was a valid business purpose as long as the reduction of non-federal taxes was greater than the reduction of federal taxes. In this case, any federal tax consequences were incidental.
The IRS also argued that the transactions where a purchase and sale of tax credits based on substance over form. The court stated that “[t]he Supreme Court has held that we should honor the parties’ relationships where there is a genuine multiple-party transaction with economic substance that is compelled or encourages by regulatory or business realities, is imbued with Federal tax-independent considerations, and is not shaped solely by Federal tax avoidance.” The court held that the Investors’ contributions to the partnerships and their allocation of state tax credits reflected their substance. The court based its holding on the realities of the Virginia Program (tax credits could not be freely transferred so partnership structures were required), the lack of federal tax avoidance, the intent of the partners to pool their contributions to facilitate investment, and the fact that the Investors bore sufficient risks related to their investments.
Also at issue in the case was whether the capital contributions followed by allocations of state tax credits were disguised sales, and whether the six year limitations period in section 6229(c)(2) was applicable. The court rejected the IRS’s disguised sale argument because it concluded that the substance of the transactions reflect valid contributions and allocations rather
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than sales. Because the court held that the transactions were not sales, there was not an omission of from income sufficient to trigger the six year limitations period.
d. Robucci et al. v. Commissioner; T.C. Memo. 2011-19 (1/24/11)
• Based on advice from his CPA, Taxpayer restructured sole proprietorship psychiatry practice.
• The “10%” general partnership interest ostensibly represented Taxpayer’s interest as a provider of medical services.
• The “85%” limited partner interest ostensibly represented Taxpayer’s interest attributable to his contribution of intangibles.
• PC and W had little activity.
• Corporate formalities not followed.
• Taxpayer paid SE tax on only the income attributable to 10% partner interest.
• Held: under Moline Properties analysis, (i) neither PC nor W were formed for the purpose of conducting business activity and (ii) neither of such entities actually conducted business. Therefore, both PC and W were disregarded, and all income from Rubucci LLC was subject to SE tax.
2. Series LLC (Proposed Regs Issued September 2010)
a. Background
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A number of states have enacted statutes providing for the creation of entities that may establish series, including limited liability companies (series LLCs). In general, series LLC statutes provide that a limited liability company may establish separate series. Although series of a series LLC generally are not treated as separate entities for state law purposes and, thus, cannot have members, specified members, assets, rights, obligations, and investment objectives or business purposes are “associated” with each series. Members’ association with one or more particular series is comparable to direct ownership by the members in such series, in that their rights, duties, and powers with respect to the series are direct and specifically identified. If the conditions enumerated in the relevant statute are satisfied, the debts, liabilities, and obligations of one series generally are enforceable only against the assets of that series and not against assets of other series or of the series LLC.
Certain jurisdictions have enacted statutes providing for entities similar to series LLC. For example, certain statutes provide for the chartering of a legal entity (or the establishment of cells) under a structure commonly known as a protected cell company, segregated account company or segregated portfolio company (cell company). A cell company may establish multiple accounts, or cells, each of which has its own name and is identified with a specific participant, but generally is not treated under local law as a legal entity distinct from the cell company. The assets of each cell are statutorily protected from the creditors of any other cell and from the creditors of the cell company.
Under current law, there is little specific guidance regarding whether, for Federal tax purposes, a series (or cell) is treated as an entity separate from other series or the series LLC (or other cells or the cell company, as the case may be) or whether the series LLC and all of its series (or cells) should be treated as a single entity.
b. Entity Classification for Federal Tax Purposes
(1) Regulatory framework. Treasury Regulation § 301.7701-3(a) generally provides that an eligible entity, which is a business entity that is not a corporation under § 301.7701-2(b), may elect its classification for Federal tax purposes.
(2) Separate entity classification. The threshold question for determining the tax classification of a series of a series LLC or a cell of a cell company is whether an individual series or cell should be considered an entity for Federal tax purposes. The determination of whether an organization is an entity separate from its owners for Federal tax purposes is a matter of Federal tax law and does not depend on whether the organization is recognized as an entity under local law. § 301.7701-1(a)(1).
c. Domestic Statutes
Although § 301.7701-1(a)(1) provides that state classification of an entity is not controlling for Federal tax purposes, the characteristics of series LLCs and cell companies under their governing statutes are an important factor in analyzing whether series and cells generally should be treated as separate entities for Federal tax purposes.
Series LLC statutes have been enacted in Delaware, Illinois, Iowa, Nevada, Oklahoma, Tennessee, Texas, Utah and Puerto Rico. Delaware enacted the first series LLC statute in 1996. Del. Code Ann. Tit. 6, section 18-215 (the Delaware statute). Statutes enacted subsequently by
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other states are similar, but not identical, to the Delaware statute. All of the statutes provide a significant degree of separateness for individual series within a series LLC, but none provides series with all of the attributes of a typical state law entity, such as an ordinary limited liability company. Individual series generally are not treated as separate entities for state law purposes. However, in certain states (currently Illinois and Iowa), a series is treated as a separate entity to the extent provided in the series LLC’s articles of organization.
The Delaware statute provides that an LLC may establish, or provide for the establishment of, one or more designated series of members, managers, LLC interests or assets. Under the Delaware statute, any such series may have separate rights, powers, or duties with respect to specified property or obligations of the LLC or profits and losses associated with specified property or obligations, and any such series may have a separate business purpose or investment objective. Additionally, the Delaware statute provides that the debts, liabilities, obligations, and expenses of a particular series are enforceable against the assets of that series only, and not against the assets of the series LLC generally or any other series of the LLC, and, unless the LLC agreement provides otherwise, none of the debts, liabilities, obligations, and expenses of the series LLC generally or of any other series of the series LLC are enforceable against the assets of the series, provided that the following requirements are met: (1) the LLC agreement establishes or provides for the establishment of one or more series; (2) records maintained for any such series account for the assets of the series separately from the other assets of the series LLC, or of any other series of the series LLC; (3) the LLC agreement so provides; and (4) notice of the limitation on liabilities of a series is set forth in the series LLC’s certificate of formation.
Unless otherwise provided in the LLC agreement, a series established under Delaware law has the power and capacity, in its own name, to contract, hold title to assets, grant liens and security interests, and sue and be sued. A series may be managed by the members of the series or by a manager. Any event that causes a manager to cease to be a manager with respect to a series, in itself, will not cause the manager to cease to be a manager of the LLC or of any other series of the LLC.
Under the Delaware statute, unless the LLC agreement provides otherwise, any event that causes a member to cease to be associated with a series, in itself, will not cause the member to cease to be associated with any other series or with the LLC, or cause termination of the series, even if there are no remaining members of the series. Additionally, the Delaware statute allows a series to be terminated and its affairs wound up without causing the dissolution of the LLC. However, all series of the LLC terminate when the LLC dissolves. Finally, under the Delaware statute, a series generally may not make a distribution to the extent that the distribution will cause the liabilities of the series to exceed the fair market value of the series’s assets.
3. Explanation of Provisions
With one exception, the proposed regulations do not apply to series or cells organized or established under the laws of a foreign jurisdiction. The one exception is that the proposed regulations apply to a foreign series that engages in an insurance business.
The proposed regulations provide that, for Federal tax purposes, a domestic series, whether or not a separate entity for local law purposes, is treated as an entity formed under local law. Because a series is treated as an entity formed under local law under the proposed
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regulations, whether it is recognized as a separate entity for Federal tax purposes is determined under § 301.7701-1 and general tax principles. The proposed regulations further provide that the classification of a series that is recognized as a separate entity for Federal tax purposes is determined under §301.7701-1(b), which provides the rules for classifying organizations that are recognized as entities for Federal tax purposes.
The proposed regulations define a series organization as an entity that is considered a separate entity for state law purposes that establishes and maintains, or under which is established and maintained, a series. A series organization includes a series LLC, series partnership, series trust, protected cell company, segregated cell company, segregated portfolio company, or segregated account company.
The proposed regulations define a series statute as a statute of a state or foreign jurisdiction that explicitly provides for the organization or establishment of a series by an entity that is considered a separate entity for state law purposes and explicitly permits (1) members or participants of a series organization to have rights, powers, or duties with respect to the series; (2) a series to have separate rights, powers, or duties with respect to specified property or obligations; and (3) the segregation of assets and liabilities such that none of the debts and liabilities of the series organization (other than liabilities to the state or foreign jurisdiction related to the organization or operation of the series organization, such as franchise fees or administrative costs) or of any other series of the series organization are enforceable against the assets of a particular series of the series organization. For purposes of this definition, a “participant” of a series organization includes an officer or director of the series organization who has no ownership interest in the series or series organization, but has rights, powers, or duties with respect to the series.
The IRS and the Treasury Department believe that, notwithstanding that series differ in some respects from more traditional local law entities, domestic series generally should be treated for Federal tax purposes as entities formed under local law. Because Federal tax law, and not local law, governs the question of whether an organization is an entity for Federal tax purposes, it is not dispositive that domestic series generally are not considered separate entities for local law purposes. Additionally, the IRS and the Treasury Department believe that, overall, the factors supporting separate entity status for series outweigh the factors in favor of disregarding series as entities separate from the series organization and other series of the series organization. Specifically, managers and equity holders are “associated with” a series, and their rights, duties, and powers with respect to the series are direct and specifically identified. Also, individual series may (but generally are not required to) have separate business purposes and investment objectives. The IRS and the Treasury Department believe these factors are sufficient to treat domestic series as entities formed under local law.
The rules provided in the proposed regulations provide a degree of greater certainty to both taxpayers and the IRS regarding the tax status of domestic series (and foreign series that conduct insurance businesses). In effect, taxpayers that establish domestic series are placed in the same position as persons that file a certificate (or articles) of organization for a state law entity. The IRS and the Treasury Department believe that the approach of the proposed regulations is straightforward and administrable, and is preferable to engaging in a case by case determination of the status of each series that would require a detailed examination of the terms of the relevant statute. Finally, the IRS and the Treasury Department believe that a rule
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generally treating domestic series as local law entities would be consistent with taxpayers’ current ability to create similar structures using multiple local law entities that can elect their federal tax classification pursuant to Treas. Reg. § 301.7701-3.
a. Effect of Local Law Classification on Tax Collection
The proposed regulations provide that, to the extent Federal or local law permits a creditor to collect a liability attributable to a series from the series organization or other series of the series organization, the series organization and other series of the series organization may also be considered the taxpayer from whom the tax assessed against the series may be collected pursuant to administrative or judicial means. Further, when a creditor is permitted to collect a liability attributable to a series organization from any series of the series organization, a tax liability assessed against the series organization may be collected directly from a series of the series organization by administrative or judicial means.
b. Employment Tax and Employee Benefits Issues
(1) Employment tax. An entity must be a person in order to be an employer for Federal employment tax purposes. See IRC §§ 3121(b), 3306(a)(1), 3306(c), and 3401(d) and Treas. Reg. § 31.3121(d)-2(a). However, status as a person, by itself, is not enough to make an entity an employer for federal employment tax purposes. The entity must also satisfy the criteria to be an employer under federal employment tax statutes and regulations for purposes of the determination of the proper amount of employment taxes and the party liable for reporting and paying the taxes. Treatment of a series as a separate person for federal employment tax purposes would create the possibility that the series could be an “employer” for federal employment tax purposes, which would raise both substantive and administrative issues.
The series structure would make it difficult to determine whether the series or the series organization is the employer under the relevant criteria with respect to the services provided. For example, if workers perform all of their services under the direction and control of individuals who own the interests in a series, but the series has no legal authority to enter into contracts or to sue or be sued, could the series nonetheless be the employer of the workers? If workers perform services under the direction and control of the series, but they are paid by the series organization, would the series organization, as the nominal owner of all the series assets, have control over the payment of wages such that it would be liable as the employer under IRC § 3401(d)?
The structure of a series organization could also affect the type of employment tax liability. For example, if a series were recognized as a distinct person for federal employment tax purposes, a worker providing services as an employee of one series and as a member of another series or the series organization would be subject to tax under the Federal Insurance Contributions Act (“FICA”) on the wages paid for services as an employee and self-employment tax on the member income. Note further that, if a domestic series were classified as a separate entity that is a business entity, then, under § 301.7701-3, the series would be classified as either a partnership or a corporation. While a business entity with one owner is generally classified as a corporation or is disregarded for federal tax purposes, such an entity cannot be disregarded for federal employment tax purposes. See § 301.7701-2(c)(2)(iv).
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Once the employer is identified, additional issues arise, including but not limited to the following: How would the wage base be determined for employees, particularly if they work for more than one series in a common line of business? How would the common paymaster rules apply? Who would be authorized to designate an agent under IRC § 3504 for reporting and payment of employment taxes, and how would the authorization be accomplished? How would the statutory exceptions from the definitions of employment and wages apply given that they may be based on the identity of the employer? Which entity would be eligible for tax credits that go to the employer such as the Work Opportunity Tax Credit under IRC § 51 or the tip credit under IRC § 45B? If a series organization handles payroll for a series and is also the nominal owner of the series assets, would the owners or the managers of the series organization be responsible persons for the Trust Fund Recovery Penalty under IRC § 6672?
Special administrative issues might arise if the series were to be treated as the employer for federal employment tax purposes but not for state law purposes. For example, if the series were the employer for Federal employment tax purposes and filed a Form W-2, “Wage and Tax Statement,” reporting wages and employment taxes withheld, but the series were not recognized as a separate entity for state law purposes, then administrative problems might ensue unless separate Forms W-2 were prepared for state and local tax purposes. Similarly, the IRS and the states might encounter challenges in awarding the Federal Unemployment Tax (“FUTA”) credit under IRC § 3302 to the appropriate entity and certifying the amount of state unemployment tax paid.
In light of these issues, the proposed regulations do not currently provide how a series should be treated for Federal employment tax purposes.
(2) Employee Benefits. Various issues arise with respect to the ability of a series to maintain an employee benefit plan, including issues related to those described above with respect to whether a series may be an employer. The proposed regulations do not address these issues. However, to the extent that a series can maintain an employee benefit plan, the aggregation rules under IRC § 414(b), (c), (m), (o) and (t), as well as the leased employee rules under IRC § 414(n), would apply. In this connection, the IRS and Treasury Department expect to issue regulations under IRC § 414(o) that would prevent the avoidance of any employee benefit plan requirement through the use of the separate entity status of a series.
II. Employment Tax Update A. Taxation Of Compensatory Income (Wages of Employees and Net Earnings
From Self-Employment (“NESE”)) 1. 2010
Historically, individual taxpayers have been subject to a tax – of 15.3% on either wages, in the case of employees, in which case the tax was split equally between the employer (for who it was deductible) and the employee (for whom it was not deductible), or on NESE, in which case, one-half of the tax was deductible in order to simulate the deduction available to the employee. NESE includes amounts of ordinary income (other than dividends and rent) from a
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trade or business carried on by the individual or by a partnership in which the individual is a partner other than a general partner.5
As part of the financing for Social Security and Medicare benefits, a tax is imposed under Chapter 21 of the Code on the wages of an individual received with respect to his or her employment under FICA. A similar tax is imposed on the NESE of an individual under the Self- Employment Contributions Act (“SECA”) under IRC § 1401. The FICA tax has two components. Under the old-age, survivors, and disability insurance component (“OASDI”), the rate of tax is 12.4% , half of which is imposed on the employer, and the other half of which is imposed on the employee.6 Under IRC § 3111(d), the employer’s half of the OASDI (6.2%) is forgiven with respect to wages with respect to employment between March 18, 2010 and December 31, 2010 of an employee hired after February 3, 2010.7 The amount of wages subject to this component is capped at $106,800 for 2010 and 2011. Under the hospital insurance (“HI”) component, the rate is 2.9%, also split equally between the employer and the employee. The amount of wages subject to the HI component of the tax is not capped. The wages of individuals employed by a business in any form (for example, a C corporation) generally are subject to the FICA tax.8
For SECA tax purposes, NESE means the gross income derived by an individual from any trade or business carried on by the individual, less the deductions attributable to the trade or business that are allowed under the self-employment tax rules.9 Specified types of income or loss are excluded, such as rentals from real estate in certain circumstances, dividends and interest, and gains or loss from the sale or exchange of a capital asset or from timber, certain minerals, or other property that is neither inventory nor held primarily for sale to customers.
For 2010, under IRC § 3301(1), employers are obligated to pay FUTA of 6.2% of the first $7,000 of wages for each employee. FUTA is subject to a credit pursuant to IRC § 3302(a)(1) of 5.4% for amounts paid by the employer into a certified state unemployment fund.
For an individual who is a partner in a partnership, the NESE generally include the partner’s distributive share (whether or not distributed) of income or loss from any trade or business carried on by the partnership (excluding specified types of income, such as capital gains and dividends, as described above). This rule applies to individuals who are general partners. A special rule under IRC § 1402(a)(13) applies for limited partners of a partnership. In determining a limited partner’s NESE, an exclusion is provided for his or her distributive share of partnership income or loss. The exclusion does not apply with respect to guaranteed payments
5 IRC § 1402(a). 6 IRC §§ 3101 and 3111. 7 There have been various proposals to extend the tax holiday. 8 Modified adjusted gross income is adjusted gross income increased by the amount excluded from income as foreign earned income under IRC § 911(a)(1), net of the deductions and exclusions disallowed with respect to foreign earned income. 9 For purposes of determining net earnings from self-employment, taxpayers are permitted a deduction from net earnings from self-employment equal to the product of the taxpayer’s net earnings (determined without regard to this deduction) and one-half of the sum of the rates for OASDI (12.4%) and HI (2.9%), i.e., 7.65% of net earnings.
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to the limited partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.
Individuals are entitled to an above-the-line deduction equal to one-half of the self- employment taxes under IRC § 164(f).10
For 2010, the effective rates of self-employment taxes taking into account the deduction of one-half of the self-employment taxes are:
Marginal Rate
Effective Rate on NESE ≥ $106,80011 Effective Rate on NESE < 106,800
0% 2.9% 15.3 % 10% 2.755 % 14.535 % 15% 2.6825 % 14.1525 % 25% 2.5375 % 13.3875 % 28% 2.494 % 13.158 % 33% 2.4215 % 12.7755 % 35% 2.3925 % 12.6225 %
2. 2011-2012
For the first six months of 2011, under IRC § 3301, employers are obligated to pay FUTA of 6.2% of the first $7,000 of wages for each employee, and 6.0% with respect to the remainder of 2011 and 2012. Under IRC § 3302, FUTA is subject to a credit of 5.4% for amounts paid by the employer into a certified state unemployment fund.
The tax rate reduction is currently scheduled to revert to pre-2003 rates for tax years beginning on January 1, 2011.12 If the rates are restored, the deduction, when applied to an individual at the highest marginal rate (39.6%) will result in an effective rate of 12.2706% of net earnings from self-employment up to the OASDI benefit base and 2.3258% for self-employment income in excess of the benefits base. The OASDI benefit base will not rise for 2011.13 If the rates are not lowered, the effective rates of self-employment tax in 2011 and 2012 will be:
10 This deduction reflects the fact that the FICA rates apply to an employee’s wages, which do not include FICA taxes paid by the employer, whereas a self-employed individual’s net earnings are economically the equivalent of an employee’s wages plus the employer share of FICA taxes. The deduction is intended to provide parity between FICA and SECA taxes. In addition, self-employed individuals may deduct one-half of self-employment taxes for income tax purposes under IRC § 164(f). 11 Under the 2010 tax rate schedules, taxable income of $106,800 (which may be different that NESE) places the taxpayer in the 33% tax bracket. 12 Pub. L. 108-27 § 105(a) as extended to December 31, 2010 by P.L. 107-358 § 2. 13 The benefit base remained the same ($106,800) for 2009, 2010, and 2011. Rates are announced in late October or November of each and are available at http://www.ssa.gov/OACT/COLA/cbb.html.
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Marginal Rate Effective Rate on NESE ≥ $106,800 Effective Rate on NESE < 106,800
0% 2.9% 15.3% 15% 2.6825% 14.1525% 28% 2.494% 13.158% 31% 2.3635% 12.9285% 36% 2.378% 12.546%
39.6% 2.325% 12.2706%
3. 2013 and thereafter
For 2013, under IRC § 3301, employers are obligated to pay FUTA of 6.0% of the first $7,000 of wages for each employee. Under IRC § 3302, FUTA is subject to a credit of 5.4% for amounts paid by the employer into a certified state unemployment fund.
The Patient Protection and Affordable Care Act (“PPACA”), P.L. 111-148 (March 23, 2010), and the Health Care and Education Reconciliation Act of 2010 (“HCERA”), P.L. 111-152 (March 30, 2010), make significant changes to the treatment of compensatory income.
The PPACA effectively increases the HI tax by 0.9% on NESE in excess of $250,000 for a married couple, $125,000 for a married person filing separately and $200,000 for all other individuals and includes all previously untaxed income in excess of these amounts.14
The uncapped HI tax will be increased by 0.9% Medicare tax will be imposed after 2012 on wages and self-employment income over threshold amounts.15 The threshold amounts are $250,000 for a married couple, $125,000 for a married person filing separately and $200,000 for all other individuals. This tax is to be withheld from employees, but only to the extent the employee’s wages from the employer exceed the base amount (thus, the employer may disregard the employee’s spouse’s wages).16 The employee is liable for any of the additional hospital tax.17 As with other hospital taxes, a self-employed person is liable for the payment of the tax.18
The effective rate will increase for NESE after 2012 by increase of the medicare hospital tax by 0.9% and the elimination of the above-the-line deduction for 0.9% increase19 the effective rate above $200,000 ($250,000 for married filing jointly) to 3.8%. As noted above, the 0.9% additional hospital tax is not eligible for the deduction of one-half of the self-employment taxes so the effective rate for above-the-line deduction, so the effective rate of the self-employment taxes will be:
14 IRC § 3101(b). 15 IRC §§ 3101(b)(2) and 1401(b)(2). 16 IRC § 3102(f)(1). 17 IRC § 3102(f)(2). 18 IRC § 1401(b)(2). 19 IRC § 1401(b)(2).
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Effective Rate on NESE < OASDI Benefit Base
0% 2.9% 15.3 % 10% 2.755 % 14.535 % 15% 2.6825 % 14.1525 % 25% 2.5375 % 13.3875 % 28% 2.494 % 13.158 % 33% 2.4215 % 12.7755 % 35% 2.3925 % 12.6225 %
39.6% 2.3258% 12.2706% 39.6%20 3.258% 12.2706%
A new Medicare tax has been imposed on what the Joint Committee on Taxation describes as an “Unearned Income Medicare Contribution.”21 For taxable years beginning after 2012, in the case of an individual (regardless of whether employed), an estate, or a trust is subject to a tax of 3.8% of an unearned income Medicare contribution tax is imposed. In the case of an individual, the tax is 3.8 % of the lesser of net investment income or the excess of modified adjusted gross income22 over the threshold amount.23 The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.24 This tax is administered in a manner similar to SECA taxes, with the taxpayer – rather than the taxpayer’s employer – responsible for payment of the tax.
Net investment income is investment income reduced by the deductions properly allocable to such income. Investment income is the sum of (i) gross income from interest, dividends, annuities, royalties, and rents (other than income derived from any trade or business to which the tax does not apply), (ii) other gross income derived from any business to which the tax applies, and (iii) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the tax does not apply.25 Net investment income does not include any income treated as NESE.26 In the case of a trade or business, the tax applies if the trade or business is a passive activity with respect to the taxpayer or the trade or business consists of trading financial instruments or
20 For incomes above $200,000 ($250,000 for married filing jointly) 3.8%. 21 Joint Committee on Taxation, Technical Explanation of the Revenue Provisions of the “Reconciliation Act of 2010,” as Amended, in Combination with the “Patient Protection and affordable Care Act” JCX-18-10 (March 21, 2010). 22Modified adjusted gross income is adjusted gross income increased by the amount excluded from income as foreign earned income under IRC § 911(a)(1), net of the deductions and exclusions disallowed with respect to foreign earned income. 23 IRC § 1411(a)(1)(B). 24 IRC § 1411(b). 25 IRC § 1411(c). 26 IRC § 1411(c)(6).
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commodities.27 The tax does not apply to other trades or businesses conducted by a sole proprietor, partnership, or S corporation.28 Income, gain, or loss on working capital is not treated as derived from a trade or business.29
As noted above, there is a deduction for one-half of the SECA tax paid, both in determining the deduction for NESE, and for income tax purposes.30 This deduction will not be available for the additional hospital tax (i.e., the 0.9% increase). Because the tax on unearned income is imposed under IRC § 1411 rather than IRC § 1401 none of it should be excluded from adjusted gross income so that the effective rate should be 3.8% rather than the 3.258% (a difference of 0.542%) imposed on corresponding amount of NESE.
B. Proposals to Impose Self-Employment Tax on S Corporations Traditionally, there has been a perceived problem in underpayment of employment taxes
by S corporation employees.31 In December 2009, the General Accountability Office (“GAO”) released a report entitled “Tax Gap: Actions Needed to Address Noncompliance with S Corporation Tax Rules”32 a portion of which was entitled, “Inadequate Wage Compensation to S Corporation Shareholders Creates Employment Tax Noncompliance, Which Could be Addressed through Legislative or Administrative Changes.” and which concluded by setting forth options to legislatively and administratively increase the amount of employment tax collected from S corporation shareholders.33 In addition, there has been increasing pressure on S corporations with a single shareholder to increase withholding.34
In light of this it is not surprising that the American Jobs and Closing Tax Loopholes Act of 2010 (“AJCTLA”), which was considered by Congress in early to mid-2010, contained
27 IRC § 1411(c)(2). 28 IRC § 1411(c)(4). 29 IRC § 1411(c)(3). 30 IRC §§ 1402(a)(12) and 164(f). 31 For a discussion of this issue see Ribstein and Keatinge, Ribstein and Keatinge on Limited Liability Companies 2d Ed (West, 2010), at §§ 21.5, 21.12. 32 GAO-10-195, Noncompliance with S Corporation Tax Rules, December 2009. 33 Among the legislative options presented in the GAO study were “Make Net Business Income Subject to Employment Taxes,” Make Net Business Income for Service Sector Businesses Subject to Employment Taxes,” Make Net Business Income for Majority Shareholders Subject to Employment Taxes,” and “Make Payments to Active Shareholders Subject to Employment Tax,” and “Make Payments to Active Shareholders Up to a Dollar Tolerance Subject to Employment Tax.” In addition, the GAO discussed another option, “Retain Character of Income Between Entities” under which income that flows from a partnership to an S corporation will retain its self- employment tax character until it is passed to an individual shareholder. 34 See, e.g., Fact Sheet 2008-25, August 2008 (http://www.irs.gov/newsroom/article/0,,id=200293,00.html) (“Subchapter S corporations should treat payments for services to officers as wages and not as distributions of cash and property or loans to shareholders. . . . The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.”); Watson v. U.S., 105 AFTR 2d 2010–908 (DC IA May 27, 2010) (sustaining an IRS determination that a sole shareholder of an S corporation should treat $130,730 of the “dividend” payments for 2002 and $175,470.00 for 2003 as compensation).
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provisions that addresses the employment/self-employment status of S corporation shareholders and limited partners.35 Under the AJCTLA, a shareholder’s share of income from a trade or business of an S corporation would have been taken into account in determining NESE if (1) the S corporation is engaged in a professional service business that is principally based on the reputation and skill of three or fewer employees or (2) the S corporation is a partner in a professional service business. Proposed IRC § 1402(m). The shareholder’s NESE would have been limited to the same types of income as would be applicable to a partnership.36 A shareholder’s NESE would include the distributive share of certain family members.
A professional services business would have been defined as “any trade or business if substantially all of the activities of such trade or business involve providing services in the fields of health, law, lobbying, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, investment advice or management, or brokerage services.”
In determining whether an S corporation shareholder would have been subject to the new rules, there are two distinct sets of circumstances that would have been relevant: (1) an S corporation based on the skill or reputation of three or few employees, and (2) an S corporation that is a partner in personal services partnership. The first would have been the unusual test of “the reputation and skill of three or fewer employees.” Apparently, the test was not going to refer to the number of owners, the participation of the celebrated employees, or possibly even whether the reputation is in the area in which the employee is serving. Particularly in areas such as performing arts and athletics, if a similar provision is enacted, it may become important not to make the celebrated person an employee. The obvious target of the “reputation and skill” would have been the closely held professional practice, even where there are several employees or shareholders. The Joint Committee commentary appears to confirm that the persons whose reputation is considered must be employees.37 The second test would appear to have been designed to avoid the circumstances in which an individual would employ an S corporation to reduce NESE from a professional services partnership by interposing the S corporation, paying himself or herself a salary subject to employment taxes and distributing the balance as dividends not subject to SECA. While such an arrangement would have been covered by this provision, the provision would also have covered a more widely held S corporation if the S corporation’s income was largely based on professional services income from the partnership.38
35 Section 413(a) of the AJCLTA, H.R. 4213, 111th Cong. 2d Sess. As of September 15, 2010, the fate of the AJCLTA is uncertain. 36 Joint Committee on Taxation, Technical Explanation of the Revenue Provisions of the “American Jobs And Closing Tax Loopholes Act of 2010,” JCX-29-10 (May 28, 2010) at page 292 (“As under the present-law self- employment tax rules in the case of a trade or business carried on by a partnership, certain items of income or loss are excluded from net earnings from self-employment of an S corporation shareholder under the provision, such as certain rental income, dividends and interest, and certain capital gains and losses.”). 37Joint Committee on Taxation, Technical Explanation of the Revenue Provisions of the “American Jobs And Closing Tax Loopholes Act of 2010,” JCX-29-10 (May 28, 2010) at page 292 (“It is intended that an employee include an individual who is considered an employee for Federal tax purposes.”). 38 An example in Joint Committee on Taxation, Technical Explanation of the Revenue Provisions of the “American Jobs And Closing Tax Loopholes Act of 2010,” JCX-29-10 (May 28, 2010) at page 292 explains this:
For example, assume that an S corporation’s stock is owned by a group of architects. The S corporation becomes a partner in a partnership that is formed to enter a competition to design a
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With respect to partnerships, the statute would have denied the exclusion from NESE available to “limited partners” with respect to professional services business conducted by partnerships. This section appears to codify and expand a provision of the proposed regulations issued in 1997 addressing a similar provision. Under the proposed regulations,39 a person providing services to a “personal services” partnership would not be entitled to be treated as a limited partner, and, thus, would be required to include his or her distributive share in income.40
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particular building. The other partners are architects that are not owners of the S corporation. The partnership wins the competition and the partners, including shareholders of the S corporation, perform architectural services for 18 months in connection with the construction of the building that was the subject of the competition. At the same time, the S corporation provides architectural services with respect to the design and construction of several other buildings. At the end of the 18 months, the partnership is terminated. The S corporation is not a disqualified S corporation because substantially all its activities are not performed in connection with the partnership.
39 Prop. Treas. Reg. § 1.1402(a)-2 (REG-209824-96) Fed. Reg. Vol. 62, No. 8, p. 1702 (January 13, 1997). However, section 935 of Taxpayer Relief Act of 1997 (P.L. 105-34), Congress imposed a moratorium on regulations regarding employment taxes of limited partners. The moratorium provided that any regulations relating to the definition of a limited partner for self-employment tax purposes could not be issued or effective before July 1, 1998. No regulations have been issued to date. 40 The proposed rules for determining who is a general partner for purposes of determining the SECA treatment of partners use similar tests to determine whether a partnership is a “service partnership.” Under Prop. Reg § 1.1402(a)-2(h)(6) partners in a “service partnership” would be treated as “general partners” for purposes of determining NESE. The new S corporation expands the definition of “professional service business” beyond that of “service partnership” to add several new categories of services: lobbying, performing arts, athletics, investment advice or management, or brokerage services.
Partnership Tax Update
A. Codification of Economic Substance Doctrine
B. Developments in the Treatment of LLCs as Partnerships and Disregarded Entities
1. Disguised Sales (707(a)(2)(B)) and Economic Substance Doctrine
a. U.S. District Court of New Jersey applies substance over form analysis to recast purported capital contribution of assets to partnership and transfer of loan proceeds to transferring partner as a disguised sale under IRC § 707(a)(2)(B). In re G-I Holdings, Inc., 105 AFTR 2d 2010-697 (Dec. 14, 2009). After applying a Culbertson analysis to concluded that the relationship of the parties constituted a partnership for federal income tax purposes, the Court concluded that the substance of the transactions at issue produced tax results inconsistent with their form in the underlying document. The Court held that, as a matter of substance, the taxpayer’s transfer of $480 million in assets to the partnership are properly viewed as a direct transfer of money or other property by a partner to a partnership within the meaning of IRC § 707(a)(2)(B)(i). The Court further found that loan proceeds of $460 million, paid by a bank to such transferring partner on the same date, constituted an indirect transfer of money or other property by the partnership to a partner within the meaning of IRC § 707(a)(2)(B)(ii). The Court found that the bank payment was structured to function as a payment to such partner in substance, and that when viewed together, the transfers to the partnership and the payment to the partner, are properly characterized as a sale of property pursuant to IRC § 707(a)(2)(B)(iii).
b. U.S. Tax Court recasts capital contribution of assets to partnership and transfer of loan proceeds to transferring partner as a disguised sale under IRC § 707(a)(2)(B). Canal Corp. v. Commissioner, 135 T.C. No. 9, No. 14090-06 (August 5, 2010). W, a wholly owned subsidiary of parent, P, proposed to transfer its assets and most of its liabilities to a newly formed LLC in which W and GP, an unrelated corporation, would have ownership interests. P hired S, an investment bank, and PWC, an accounting firm, to advise it on structuring the transaction with GP. P also asked PWC to issue an opinion on the tax consequences of the transaction and conditioned the closing on receiving a “should” opinion from PWC that the transaction qualified as tax free. PWC issued an opinion that the transaction should not be treated as a taxable sale but rather as a tax free contribution of property to a partnership. W contributed approximately two-thirds of the LLC’s total assets in 1999 in exchange for a 5% interest in the LLC and a special distribution of cash. W used a portion of the cash to make a loan to P in return for a note from P. After the transaction, W’s only assets were its LLC interest, the note from P and a corporate jet. The LLC obtained the funds for the cash distribution by receiving a bank loan. GP guaranteed the LLC’s obligation to repay the loan. W agreed to indemnify GP if GP were called on to pay the principal of the bank loan pursuant to its guaranty. The LLC thereafter borrowed funds from a financial subsidiary of GP to retire the bank loan. GP entered into a separate transaction in 2001 that required it to divest its entire interest in the LLC for antitrust purposes. W subsequently sold its LLC interest to GP, and GP then sold the entire interest in the LLC to an unrelated party. P reported gain from the sale on its consolidated Federal income tax return for 2001. The IRS determined that P should have reported a gain when W contributed its assets to the LLC in 1999. The IRS has also asserted a substantial understatement penalty under IRC § 6662(a) against P. Loan was guaranteed by GP. W agreed to indemnify GP if GP were called upon to pay the bank loan.
c. Va. Hist. Tax Cred. Fund 2001 LP v. Commissioner, T.C. Memo. 2009-295. Investors in partnership formed for the purpose of allocating state tax credits to the Investors were in fact partners in the partnership.
2. Series LLC (Proposed Regs Issued September 2010)
a. Background
b. Entity Classification for Federal Tax Purposes
(1) Regulatory framework. Treasury Regulation § 301.77013(a) generally provides that an eligible entity, which is a business entity that is not a corporation under § 301.7701-2(b), may elect its classification for Federal tax purposes.
(2) Separate entity classification. The threshold question for determining the tax classification of a series of a series LLC or a cell of a cell company is whether an individual series or cell should be considered an entity for Federal tax purposes. The determination of whether an organization is an entity separate from its owners for Federal tax purposes is a matter of Federal tax law and does not depend on whether the organization is recognized as an entity under local law. § 301.7701-1(a)(1).
c. Domestic Statutes
b. Employment Tax and Employee Benefits Issues
(1) Employment tax. An entity must be a person in order to be an employer for Federal employment tax purposes. See IRC §§ 3121(b), 3306(a)(1), 3306(c), and 3401(d) and Treas. Reg. § 31.3121(d)-2(a). However, status as a person, by itself, is not enough to make an entity an employer for federal employment tax purposes. The entity must also satisfy the criteria to be an employer under federal employment tax statutes and regulations for purposes of the determination of the proper amount of employment taxes and the party liable for reporting and paying the taxes. Treatment of a series as a separate person for federal employment tax purposes would create the possibility that the series could be an “employer” for federal employment tax purposes, which would raise both substantive and administrative issues.
(2) Employee Benefits. Various issues arise with respect to the ability of a series to maintain an employee benefit plan, including issues related to those described above with respect to whether a series may be an employer. The proposed regulations do not address these issues. However, to the extent that a series can maintain an employee benefit plan, the aggregation rules under IRC § 414(b), (c), (m), (o) and (t), as well as the leased employee rules under IRC § 414(n), would apply. In this connection, the IRS and Treasury Department expect to issue regulations under IRC § 414(o) that would prevent the avoidance of any employee benefit plan requirement through the use of the separate entity status of a series.
II. Employment Tax Update
A. Taxation Of Compensatory Income (Wages of Employees and Net Earnings From Self-Employment (“NESE”))
1. 2010
2. 2011-2012