1. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Taxation of LLCs – an Overview

2. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. A Brief History of the LLC Before 1960 (limited liability meant corporate tax treatment) Kinter regulations (2 of 4) 1) Limited Liability 2) Centralized Management 3) Freely transferable ownership interests 4) Continuity of life

3. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. A Brief History of the LLC 1977 Wyoming LLC Version 1.0 Master Limited Partnerships Problem 1997 IRS changes course – who says there is no such thing as a free lunch? Check the Box

4. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Check the Box Single Member LLCs Partnership Corporation

5. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Self Employment Issues Self-employment tax 12.4% up to SS base ($113,700) plus 2.9% uncapped (with increase marginal rate to 3.8% in 2013) 1997 Proposed Regs for limited partners (500 hour test) New Obamacare passive activity income 3.8% marginal rate over income thresholds Increased incentive for active businesses to be S corps rather than LLCs

6. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Section 721 Transactions No gain or loss No 80% rule (unlike 351) Disguised Sale exceptions (i.e. watch out for distributions following contributions within 2 years)

7. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Partnership Allocations

8. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Capital Accounts Required maintaince Book Capital accounts Tax capital accounts (i.e. outside basis) Importance of examples

9. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Drafting Tax Allocation Provisions Pro rata generally not problematic. Substantial Economic Effect and other tax provisions: –Qualified Income Offset –Capital Accounts –Deficit Reduction Obligation –Minimum Gain (nonrecourse debt) –Contributed property & Bookups –754 adjustments Important not only to include “boilerplate” tax language but also to understand effects Safe Harbor vs. Targeted Allocation Drafting A trap for the unwary

10. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Dealing with Preferred Returns Profits are easy, losses are hard The basic test for substantial economic effect

11. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Substantial Economic Effect Capital Accounts Liquidating distributions in accordance with capital accounts Either a DRO, or Qualified Income Offset & Minimum Gain Chargeback Economic Equivalence Test (Dumb but Lucky)

12. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Qualified Income Offset Any Holder with a deficit in his/her capital account, as the result of unexpectedly receiving a distribution, must be allocated items of future income or gain in an amount sufficient to eliminate the deficit balance as quickly as possible. Shift Income/Gain to members with a deficit

13. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Minimum Gain Chargeback Requires that Holders who are allocated loss or depreciation deductions (i.e. nonrecourse deductions) with respect to an asset secured by nonrecourse financing must also be allocated the first gain from the sale of such asset, up to the amount of the prior deductions.

14. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Targeted Allocation Provisions First the economics Then allocation in manner to cause ending capital accounts to equal result in liquidation. Burden is transferred from drafter to tax return preparer Does not comply with safe b No certainty yet, but moving that way

15. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Profits Interest Tax consequences to recipient Tax consequences to company 409A issues

16. © 2006 Barnes & Thornburg LLP. All Rights Reserved. This page may be freely copied and distributed if kept intact and the copyright notice appears. Conclusion Good luck out there!