1. © 2014 Gray Reed & McGraw, P.C. The information contained herein is subject to change without notice E CONOMIC AND T AX I SSUES IN D RAFTING P ARTNERSHIP A GREEMENTS P ART O NE : C HOICE OF E NTITY Dan Kroll Christopher Morales Austin Carlson January 28, 2015

2. Before We Begin

3. Highway to the Next Level You Professor Kroll Next Tax Level

4. 4 Objectives  Better understanding of the two main drivers for choice of entity:  Liability Planning  Tax Planning  Better understanding of why many investment structures are so complex.

5. 5 Business Entity Choices  Corporation  C Corporation  S Corporation  REIT  Tax Exempt  Partnership  General  Limited  LLP  MLP  Limited Liability Company  Check the box flexibility

6. 6 Non-Tax Considerations  Limited Liability for Owners  Management  Corporation -- Board of Directors  LLC -- Board of Managers or Managing Member/Sole Member  Limited Partnership -- General Partner  General Partnership -- Managing Partner

7. 7 Non-Tax Considerations  Ownership Flexibility  Preferred Equity  Junior Equity  Economic Waterfalls  Profits Interests  Disproportionate Distributions

8. 8 Tax Considerations  Double Tax v. Single Tax  Losses Trapped in Entity  Basis Increase to Owners for Entity Income  Tax Basis to Owners for Entity Debt  Flexible Allocation of Tax Items  Taxable In Kind Distributions  Tax-Free Merger  Inside Basis Increase to Buyer Upon Equity Sale  “Blocker” function

9. 9 C Corporation  Double Tax  Losses Trapped  No Outside Basis Increase for Current Earnings  In Kind Distributions Are Taxable  Tax-Free Merger Possible

10. 10 Double Tax Example C Corporation Non-Corporate Shareholder Customer ExpensesIRS $13 $65 $35 $100$200 5 3 2 1 4 Revenue200 Expenses-100 Net Income100 Less: 35% Corporate Tax-35 After-Tax (Corporate)65 Less: 20% Dividend Tax-13 To Shareholder After All Taxes52 If the $65 of after-tax earnings are retained in the C Corporation, Shareholder's Tax Basis in the Shares does not increase

11. 11 Single Tax Example S Corporation or Partnership Owners Customer ExpensesIRS $20 $100 $0 $100$200 5 3 2 1 4 Revenue200 Expenses-100 Net Income100 Less: Corporate Tax-0 After-Tax (Corporate)100 Less: 20% Shareholder Tax-20 Retained Earnings80 Pass through entity distributes $100 to Owners Taxes; Owners pay $20 in tax, retain $80.

12. 12 Trapped Losses C Corp Shareholder Losses incurred by C Corp may not be used by the Shareholder Loss Allocation

13. 13 Corporate Reorganizations Target Corp Target Shareholders Exchange of Target Shares for Acquisition Corp Shares are tax-free to Target Shareholders Merger SubAcquisition Corp Shares merger

14. 14 S Corporation  Single Class of Stock  Limited Number and Type of Shareholders  No Allocation Flexibility  Technical Election Procedures and Footfaults  No basis allocation for Shareholder Debt  In-Kind Distributions are Taxable  No Disproportionate Distributions Allowed  But Redemption Safe Harbor But,  No Trapped Losses  Basis Increase for Retained Operating Earnings

15. 15 S Corporation Example AB S Corp AB $50 50 Shares AB S Corp spends $100 on deductible expenses Losses allocated 50/50

16. 16  AB S Corp needs an additional $100 for Year 2 operations  A does not have any money  B funds all $100  AB S Corp issues 100 shares to B for the extra $100 investment  Sharing Ratio is now 50 shares to A and 150 shares to B  Year 2 losses allocated $25 to A and $75 to B even though losses were all funded by B AB S Corp AB $100$0 100 Shares S Corporation Example - (continued)

17. 17 Basis Increase for S Corporation S Corporation Shareholder Customer ExpensesIRS $40 $0 $100$200 5 3 2 1 4 Revenue200 Expenses-100 Net Income100 Less: Corporate Tax-0 After-Tax (Corporate)100 Less: 40% Shareholder Tax-40 Retained Earnings60 S Corporation distributes $40 to Shareholder for Taxes; retains $60. Shareholder's Tax Basis Increases for the $60 of Retaining Earnings

18. 18  Exceptions  Small business service companies with one owner and no possibility whatsoever of capital gain transactions  C Corp to S Corp conversions Basis Increase for Earnings Avoid Trapped Losses In-Kind Distribution Rule Usually Prevents an LLC Conversion  Over 100 equity owners and cannot qualify as a Publicly Traded Partnership  Business is certain it will exit in a stock-for-stock merger or will be purchased in a 338(h)(10) deal  Blockers Friends don’t let friends form an S Corp or a C Corp for a privately- owned business.

19. 19 Initial Public Offerings ABC Corp ABC ABC LLC merger ABC ABC Corp Public $ Unless the business can qualify as a publicly traded partnership, ABC LLC will need to convert to a corporation before it consummates an initial public offering.

20. 20 Blocker Corporations Inbound foreign investment domestic corporate blocker Tax exempt entity domestic corporate blocker REIT subsidiary domestic corporate blocker Blocker corporations allow investors to indirectly receive income from domestic partnerships without being a direct partner.

21. 21 Blockers: Inbound Foreign Investment Blocker Domestic Corp (Blocker) ABCBC U.S. Partnership Foreign Investors The blocker corporation pays tax on its share of the partnership's income. Foreign investors avoid US trade or business income tax and instead are only subject to tax in their home country on any dividends received. Foreign investors will not be required to file a U.S. income tax return. Domestic Investors U.S. Real Estate Assets

22. 22 Domestic corp. will hold all investments that generate UBTI income. Income will be taxed as corporate rates at the subsidiary level and passed tax free to the tax exempt entity. Blockers: Tax Exempt UBTI Subsidiary Tax Exempt Entity Domestic Corp. (Taxable Subsidiary) UBTI Income Tax Free Dividends U.S. Partnership B C Other Investors

23. 23 Blockers: REIT Taxable Subsidiary Blocker REIT Subsidiary structure allows REIT to indirectly receive income that would otherwise disqualify the entity’s REIT status. Equity value of subsidiaries may not collectively represent more than 25% of REIT assets. Domestic Corp. (Taxable REIT Subsidiary) Real Estate Assets Management, Development, and Sales Contracts relating to Real Estate Assets (Concierge services, minor dealer gain) “Good” REIT Income “Bad” REIT Income Dividends

24. 24 Delaware Filing Fees - As of December 31, 2014

25. 25 Texas Filing Fees - As of December 31, 2014