On May 13, 2019, the IRS will change its Employer ID number (EIN) application procedure by eliminating the ability of an entity to be the “responsible party” that applies for the EIN. The responsible party that can apply for an EIN must have either a social security number (SSAN) or an international tax identification number (ITIN). An ITIN is a number the IRS issues to non-U.S. residents. Only people can have a SSAN or an ITIN so all applicants must be a person.
Arizona Attorney General Mark Brnovich announced today [March 11, 2019] that his office recently filed suit in the U.S. Supreme Court against the State of California seeking to invalidate California’s extraterritorial tax assessments and seizures, which result from an unconstitutional “doing business” tax against businesses and individuals that don’t actually conduct any business in California.
Every year, California assesses an $800 “doing business” taxes against Arizona businesses that conduct no actual business in California. Instead, their only connection to California is a mere passive, non-managing investment in a California limited liability company. California continues to assess these “doing business” taxes even though both its state courts and tax appeals agency have held that the taxes are illegal under California law.
The lawsuit filed by Arizona alleges that these taxes are plainly unconstitutional under the Due Process and Commerce Clauses of the U.S. Constitution. The Supreme Court has held that passive investment in a company located in another state is not sufficient “minimum contacts” to impose taxation under the Due Process Clause (Shaffer v. Heitner, 433 U.S. 186 (1977)). The Supreme Court has also recognized four requirements for states to impose taxes on out-of-state businesses under the Commerce Clause. California’s “doing business” assessments brazenly violate all four.
The amounts collected by these “doing business” assessments are substantial. Arizona estimates that its citizens pay over $10 million in these unconstitutional taxes to the State of California every year.
These taxes also impact Arizona’s tax collections. Since the “doing business” taxes are deductible expenses, Arizona loses an estimated $484,000 in tax revenue each year due to California’s illegal taxation.
These figures are further compounded since the tax applies to all individuals in other states who invest in California businesses.
Making matters worse, if California’s tax assessments are not paid voluntarily, California frequently further tramples on the sovereignty of other states by issuing orders to interstate banks, demanding that they transfer funds in Arizona-based accounts for back payment. Those seizure orders threaten the banks that, if they do not transfer the funds, California will take the taxes and penalties owed from the banks instead. Not surprisingly, the banks almost uniformly consent to California’s strong-arm tactics.
Exhibit G in the filing provides an example where California demanded that Wells Fargo not only transfer the $800 tax, but also a $200 “demand penalty,” a $432 “late filing penalty,” a $79 “filing enforcement fee,” and $63.40 in interest, for a “Total Tax, Penalties, Interest and Fees” of $1574.40.
The lawsuit alleges that these seizure orders violate both the Due Process Clause (by exercising jurisdiction over out-of-state funds without the requisite “minimum contacts”); and, the Fourth Amendment (by effectuating seizures without a warrant, probable cause, or involvement of any court). Those seizure orders further preclude the banks from filing any court challenge.
Arizona’s suit seeks to end California’s unconstitutional tax encroachments.
- Copy of the filing.
- Copy of NTUF brief.
- Copy of DRI and NFIB brief.
- Copy of Southeastern Legal Foundation and Cato Institute brief.
- Copy of Law Professors brief.
If you are a non-U.S. citizen who is the sole member/owner of a U.S. limited liability company treated by the IRS as a disregarded entity (a “DE”) you must file an IRS form 5472 with the IRS on or before the due date of the Form 5472 or become liable to pay the IRS a penalty of $25,000. If you must file Form 5472 and fail to file it before the due date and then fail to file the Form 5472 within 90 days after the due date you will become liable for an additional $25,000 penalty.
The U.S. DE LLC must file Form 5472 if it had a reportable transaction with a foreign or domestic related party. To learn what are reportable transactions, who are related parties and more about this topic read my article called “LLCs 100% Owned by Foreign Persons Must File IRS Form 5472 or be Liable for $25,000 Penalty.”
[bctt tweet=”Learn about the $25,000 penalty when a foreign person who owns a U.S. LLC that is a disregarded entity fails to file IRS form 5472.” username=”azattorney”]
The Tax Cuts and Jobs Act of 2017 made substantial changes to the way companies and their owners are taxed under the federal income tax laws. LLCs can be taxed four ways:
- sole proprietorship if the LLC has one owner or is owned solely by a married couple as community property,
- partnership if the LLC has two or more members,
- C corporation if the LLC files an IRS form 8832 and elects to be taxed as a C corporation under subchapter C of the Internal Revenue Code of 1986, as amended, and
- S corporation if the LLC files an IRS form 2553 and elects to be taxed as an S corporation under subchapter S of the Internal Revenue Code of 1986, as amended.
If you have an entity that owns investment property or that operates a business you must now consider which of the federal income tax methods is best for your company under the new tax law. If the best tax method is not the company’s current tax method then you may want to change the company’s current tax method to the best method. However, before you make the change, have your tax advisor do an analysis to determine if there will be a cost to make the change. See for example, “Converting from C to S corp. may be costlier than you think.”
The first step is to determine which tax method will be best for your company is to compare the tax consequences of the different tax methods under common scenarios. An excellent article that may help you make a decision as to which tax method is best for you is “2017 Tax Act.” This is a must read article for all small business owners. The authors give examples of operating and selling a businesses taxed as:
- LLC/S corporation with qualified business income (QBI)
- LLC/S corporation
- C corporation
The examples in the article will give you a better understanding of the new tax law and how it will affect you and your company.
For existing companies that are not taxed as S corporations that want to change their tax method to S corporation, these companies must file the IRS form 2553 no more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or at any time during the tax year preceding the tax year it is to take effect. If your company wants to change its tax method to C corporation the change cannot take effect more than 75 days before the date the the IRS form 8832 is filed, nor can it take effect later than 12 months after the IRS form 8832 is filed.
Read the complete text of the 2017 law that was first called the “Tax Cuts and Jobs Act,” but its name was changed today to “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” President Trump is expected two sign the bill in the next two weeks.
Question 1: My multi-member LLC is taxed as a partnership. Does it need to amend its Operating Agreement because of the new partnership tax rules that become effective on January 1, 2018?
Question 2: My multi-member LLC is taxed as a partnership. It does not have an Operating Agreement. Do the members of my LLC need to sign an Operating Agreement because of the new partnership tax rules that become effective on January 1, 2018?
Answer: Yes, yes and yes until I am blue in the face. All LLCs taxed as partnerships should amend their Operating Agreements or better yet adopt a stand alone Tax Audit Agreement drafted to deal with the new tax audit rules that take effect on January 1, 2018. The new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113 affect all multi-member LLCs taxed as partnerships for federal income tax purposes.
I am an LLC attorney with a masters degree in federal income tax law from New York University School of Law who has formed 7,000+ Arizona LLCs and prepared 7,000+ Operating Agreements. As a partnership tax law attorney I recommend:
- All LLCs taxed as partnerships amend their Operating Agreements to include language that deals with issues that may arise under the new partnership tax audit rules that take effect on January 1, 2018.
- All LLCs taxed as partnerships that do not have an Operating Agreement signed by the members should adopt an Operating Agreement that includes language that deals with issues that may arise under the new partnership tax audit rules that take effect on January 1, 2018.
The members of an LLC taxed as a partnership risk substantial economic harm if the IRS audits their LLC and they have not adopted an agreement that properly addresses the issues that arise under the new tax audit rules that apply to tax years after December 31, 2017.
If you don’t believe me then read “LLCs Taxed as Partnerships Must Adopt a Tax Audit Agreement” in which 34 attorneys and CPAs recommend that LLCs taxed as partnerships amend their Operating Agreements for the new tax audit rules.
For more on this important topic see my tax audit agreement blog posts.
Hire Me to Prepare a Tax Audit Agreement for Your LLC that Has Partnership Tax Audit Provisions & Names a Partnership Representative
I’ve made it very easy to hire me for to prepare an agreement that contains the language your LLC taxed as a partnership needs for the new tax audit rules effective January 1, 2018. Complete my online Tax Audit Agreement Questionnaire.
If you have questions about the new tax audit rules or my Tax Audit Agreement, call me, partnership tax attorney Richard Keyt at 480-664-7478 or send an email to Richard at firstname.lastname@example.org.
In Arizona residential rental is the renting of Arizona real property for more than 30 days for residential purposes only.
Arizona residential rental properties are subject to state rent tax. Some, but not all, Arizona cities also tax residential rental income.
Arizona transaction privilege tax is a tax on the privilege of doing business in Arizona. TPT applies when an owner of Arizona rental real estate is engaged in business under the residential rental classification by the Model City Tax Code.
If you rent Arizona residential real estate all payments made by the tenant or on behalf of the landlord are taxable. The following is a non-inclusive list of the types of payments from tenants that are taxable rental income:
- Non-refundable and forfeited deposits
- Late payment fees
- Pet fees
- Federal rent subsidies (HUD)
The following fees passed on to the tenant are also taxable rental income:
- Common area fees
- Maintenance charges
- Homeowner association fees
- Landscaper maintenance
- Property tax
- Pool Service
- Repairs and/or improvements
Individual owners of taxable rental properties are required by law to obtain a Transaction Privilege Tax (TPT) license with the Arizona Department of Revenue (ADOR), regardless if the owner rents the property themselves or employs a property management company (PMC). A city TPT license is only required if your residential real estate is in a city that imposes a tax on residential rental rent.
Starting with the January 2018 reporting period, PMCs will no longer be permitted to report and remit TPT using their own TPT license (formerly referred to as a “Master License”) on behalf of client property owners. All taxes are to be filed and remitted using the property owners’ license numbers.
- To participate in the new E-File Solution, PMCs will need to complete and submit the Property Management License Application.
Warning to Arizona Landlords that Have Property Managers Collecting Rent Tax
Starting with the January 2018 reporting period, property management companies will no longer be permitted to report and remit transaction privilege tax using their own TPT license on behalf of client property owners. All rent taxes must be filed and remitted using the property owner’s TPT licenses. To participate in the new E-Solution, property management companies must complete the Property Management License Application.
Every residential rental property owner is required to obtain an Arizona transaction privilege tax license from the Arizona Department of Revenue (ADOR) for each location where residential rental income is taxable.
For more information and resources on Arizona residential rentals, visit the following links:
If you need assistance, call 602-716-7368 or email email@example.com. You can register, file and pay online at www.AZTaxes.gov.
On December 13, 2016, the IRS issued T.D. 9796, which created a new reporting requirement for owners of U.S. limited liability companies that are owned solely by one member that is a “foreign person.” A U.S. LLC with both of these traits is called a “reportable disregarded entity.” This new reporting requirement is set forth in Treasury Regulation 26 CFR 1.6038A-1.
Every LLC that is a reportable disregarded entity will be treated as a domestic corporation separate from its owner for the limited purposes of the reporting, record maintenance and associated compliance requirements that apply to 25 percent foreign-owned domestic corporations under section 6038A of the Internal Revenue Code. Translation: LLCs that are reportable disregarded entities will be treated as corporations with respect to the reporting obligations under section 6038A.
Reportable disregarded entities are subject to the IRS’s new information reporting requirements with respect to tax years that begin on or after January 1, 2017, and that end on or after December 13, 2017. The first returns will be due in early 2018. The taxable year of a reportable disregarded entity is the same as the taxable year of the foreign person if the foreign person has a U.S. income tax or information return filing obligation for its taxable year otherwise it is the calendar year.
Under new IRS rules entities that are taxed as partnerships or S corporations must file their federal income tax returns today, March 15, 2017, or file IRS Form 7004 to request an automatic 6-month extension of time to file the return from the due date of the return. See the instructions for IRS Form 7004.
On February 17, 2017, the Internal Revenue Service announced the conclusion of its annual “Dirty Dozen” list of tax scams. The annual list highlights various schemes that taxpayers may encounter throughout the year, many of which peak during tax-filing season. Taxpayers need to guard against ploys to steal their personal information, scam them out of money or talk them into engaging in questionable behavior with their taxes.
“We continue to work hard to protect taxpayers from identity theft and other scams,” said IRS Commissioner John Koskinen. “Taxpayers can and should stay alert to new schemes which seem to constantly evolve. We urge them to do all they can to avoid these pitfalls – whether old or new.”
Perpetrators of illegal schemes can face significant fines and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice to shut down scams and prosecute the criminals behind them. Taxpayers should keep in mind that they are legally responsible for what is on their tax return even if it is prepared by someone else.
Here is a recap of this year’s “Dirty Dozen” scams:
Phishing: Taxpayers need to be on guard against fake emails or websites looking to steal personal information. The IRS will never initiate contact with taxpayers via email about a bill or refund. Don’t click on one claiming to be from the IRS. Be wary of emails and websites that may be nothing more than scams to steal personal information. (IR-2017-15)
Phone Scams: Phone calls from criminals impersonating IRS agents remain an ongoing threat to taxpayers. The IRS has seen a surge of these phone scams in recent years as con artists threaten taxpayers with police arrest, deportation and license revocation, among other things. (IR-2017-19)
Identity Theft: Taxpayers need to watch out for identity theft especially around tax time. The IRS continues to aggressively pursue the criminals that file fraudulent returns using someone else’s Social Security number. Though the agency is making progress on this front, taxpayers still need to be extremely cautious and do everything they can to avoid being victimized. (IR-2017-22)
Return Preparer Fraud: Be on the lookout for unscrupulous return preparers. The vast majority of tax professionals provide honest high-quality service. There are some dishonest preparers who set up shop each filing season to perpetrate refund fraud, identity theft and other scams that hurt taxpayers. (IR-2017-23)
Fake Charities: Be on guard against groups masquerading as charitable organizations to attract donations from unsuspecting contributors. Be wary of charities with names similar to familiar or nationally known organizations. Contributors should take a few extra minutes to ensure their hard-earned money goes to legitimate and currently eligible charities. IRS.gov has the tools taxpayers need to check out the status of charitable organizations. (IR-2017-25)
Inflated Refund Claims: Taxpayers should be on the lookout for anyone promising inflated refunds. Be wary of anyone who asks taxpayers to sign a blank return, promises a big refund before looking at their records or charges fees based on a percentage of the refund. Fraudsters use flyers, advertisements, phony storefronts and word of mouth via community groups where trust is high to find victims. (IR-2017-26)
Excessive Claims for Business Credits: Avoid improperly claiming the fuel tax credit, a tax benefit generally not available to most taxpayers. The credit is usually limited to off-highway business use, including use in farming. Taxpayers should also avoid misuse of the research credit. Improper claims often involve failures to participate in or substantiate qualified research activities and/or satisfy the requirements related to qualified research expenses. (IR-2017-27)
Falsely Padding Deductions on Returns: Taxpayers should avoid the temptation to falsely inflate deductions or expenses on their returns to pay less than what they owe or potentially receive larger refunds. Think twice before overstating deductions such as charitable contributions and business expenses or improperly claiming credits such as the Earned Income Tax Credit or Child Tax Credit. (IR-2017-28)
Falsifying Income to Claim Credits: Don’t invent income to erroneously qualify for tax credits, such as the Earned Income Tax Credit. Taxpayers are sometimes talked into doing this by con artists. Taxpayers should file the most accurate return possible because they are legally responsible for what is on their return. This scam can lead to taxpayers facing large bills to pay back taxes, interest and penalties. In some cases, they may even face criminal prosecution. (IR-2017-29)
Abusive Tax Shelters: Don’t use abusive tax structures to avoid paying taxes. The IRS is committed to stopping complex tax avoidance schemes and the people who create and sell them. The vast majority of taxpayers pay their fair share, and everyone should be on the lookout for people peddling tax shelters that sound too good to be true. When in doubt, taxpayers should seek an independent opinion regarding complex products they are offered. (IR-2017-31)
Frivolous Tax Arguments: Don’t use frivolous tax arguments to avoid paying tax. Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims even though they have been repeatedly thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or disregard their responsibility to pay taxes. The penalty for filing a frivolous tax return is $5,000. (IR-2017-33)
Offshore Tax Avoidance: The recent string of successful enforcement actions against offshore tax cheats and the financial organizations that help them shows that it’s a bad bet to hide money and income offshore. Taxpayers are best served by coming in voluntarily and getting caught up on their tax-filing responsibilities. The IRS offers the Offshore Voluntary Disclosure Program to enable people to catch up on their filing and tax obligations. (IR-2017-35)
The IRS recently issued proposed regulations (REG-136118-15) that will, if implemented, govern the new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113. These new rules apply to partnerships and limited liability companies that are taxed as a partnership for federal income tax purposes.
The new partnership audit rules allow the IRS to assess and collect income tax at the partnership level rather than from individual partners. The new audit rules replace the partnership audit procedures created under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). The new audit rules apply to tax years beginning January 1, 2018.
The Bipartisan Budget Act of 2015 replaced the TEFRA tax matters partner with a partnership representative that must be a person or entity that has a “substantial presence” in the United States. If the partnership or LLC taxed as a partnership fails to designate a partnership representative the IRS may name the partnership representative. This is one of the reasons LLCs taxed as partnerships must amend their Operating Agreement or adopt an Operating Agreement, i.e., to name a partnership representative in the Operating Agreement to prevent the IRS from doing so. The LLC taxed as a partnership cannot change its designated partnership representative without the IRS’s consent.
The partnership representative can be an entity or a person. The partnership representative does not have to be a member of the LLC. After being appointed by the partnership or LLC, the partnership representative must then be designated on the partnership’s or LLC’s tax return.
Take care when appointing a partnership representative because the partnership representative has the sole authority to deal with the IRS on behalf of the partnership or LLC and all of its partners or members with respect to the following matters: (i) settling a tax audit, (ii) agreeing to a final partnership tax adjustment, (iii) making an Internal Revenue Code Section 6226 election to pay a partnership liability at the partner level, and (iv) agreeing to a Section 6235 extension of the period for making partnership adjustments.
The new audit rules take effect January 1, 2018. There are three important take a-ways to be learned from the new partnership audit rules:
- All existing partnerships and limited liability companies taxed as partnerships that have an Operating Agreement need to amend their Operating Agreements to add provisions dealing with the new partnership audit rules and to designate a partnership representative.
- All existing partnerships and limited liability companies taxed as partnerships that do not have an Operating Agreement need to adopt an Operating Agreement that contains provisions dealing with the new partnership audit rules and that designates a partnership representative.
- All new partnerships and limited liability companies taxed as partnerships should adopt an Operating Agreement with the new partnership audit provisions and should designate a partnership representative.
Hire Me to Amend or Prepare an Operating Agreement that Has Partnership Tax Audit Provisions and Designates a Partnership Representative
I’ve made it very easy to hire me to amend an existing LLC Operating Agreement or prepare a new Operating Agreement. The first step to hire me is to complete my online Operating Agreement questionnaire.
If you have questions about adopting or amending an LLC Operating Agreement, call me at 480-664-7478 or send an email to me at firstname.lastname@example.org.
Question: My accountant says that I need to turn my LLC into an S corporation. How do I do that?
Answer: First you need to understand that the term “S corporation” refers to a method of income tax under the Internal Revenue Code of 1986. S corporation is one of four federal income tax methods that can apply to a limited liability company.
You do not have to convert your LLC into a corporation. Instead, the LLC simply makes an election with the IRS to have the LLC taxed as an S corporation by having all members of the LLC sign an IRS Form 2553 and then file the signed Form 2553 with the IRS. See the Instructions to IRS Form 2553. If you want your LLC to be taxed as an S corporation for the tax year beginning January 1, 2021, the members must sign and file IRS Form 2553 with the IRS not later than March 15, 2021.
Caution: There are certain requirements that must be satisfied for an LLC to eligible to elect to be taxed as an S corporation. An LLC may to elect to be an S corporation only if it meets all the following tests.
- It is (a) a domestic corporation, or (b) a domestic entity such as an LLC eligible to elect to be treated as a corporation, that timely files Form 2553. If Form 2553 is not timely filed, see Relief for Late Elections, later.
- It has no more than 100 shareholders. You can treat an individual and his or her spouse (and their estates) as one shareholder for this test. You can also treat all members of a family (as defined in section 1361(c)(1)(B)) and their estates as one shareholder for this test.
- Its only shareholders are individuals, estates, exempt organizations described in section 401(a) or 501(c)(3), or certain trusts described in section 1361(c)(2)(A).
- It has no nonresident alien shareholders or members.
- It has only one class of stock (disregarding differences in voting rights). Generally, a corporation or LLC is treated as having only one class of stock if all outstanding shares of the corporation’s stock or LLC’s membership interests confer identical rights to distribution and liquidation proceeds.
There are other requirements, but the major requirements are listed above. For more about S corporations and LLCs read my blog post called “S Corporation Ignorance.”
P.S. Besides the S corporation federal income tax method, an LLC can also be called taxed as a sole proprietorship (if it has one member or two members who are married and own their membership interests as community property) partnership (if it has two or more members), a C corporation.
Question: I intend to buy a commercial real estate property. Should I form a corporation to own the real estate?
Answer: No. Nope. Absolutely not. No way. Negative. Are you kidding? Ix nay. Uh-uh. Nah. Not on your life. No way. No way José. Ixnay. I hope you don’t misunderstand my position.
An article in Forbes called “Why You Should Never Hold Real Estate In A Corporation” states:
“Take, for example, the client who contemplates the type of entity that should be used to hold a piece of real estate. For most tax practitioners, this would elicit the following Pavolovian reaction: ‘You should NEVER put real estate inside a corporation.’ And while there are very few NEVERS in the tax world, this one is pretty darn accurate.”
See also “The Perils of Holding Real Estate in a Corporation,” which discusses the federal income tax reasons it is a bad idea for a corporation to own real estate.
For the umpteen time today a client told me about the client’s discussion with a person who does not understand the difference between the type of entity formed under the law of one of the fifty states vs. the method of income tax applied to the entity by the Internal Revenue Code of 1986, as amended. The ignoramus said, “My company insists that it enter into a contract with your company, but only if your company is an S corp.” My client’s company is an LLC, but the ignorant person thinks his company cannot enter into a contract with the LLC because the LLC is not an “S corporation.”
Too many people, including CPAs and lawyers, do not understand that when they say the entity must be an S corporation they are mixing two concepts: (i) the type of entity formed under state law, and (ii) the income tax method applicable to the entity under the Internal Revenue Code. Just today I downloaded the materials to a webinar I will watch later today. The lawyer who is teaching the webinar created reference materials that constantly use the phrase “limited liability companies vs. ‘S’ corporation.” The lawyer knows better, but falls into the trap of loose talk about S corporations.
Not one single state in the United States allows people to create an S corporation. The states allow people to create, sole proprietorships, general partnerships, limited partnerships, limited liability partnerships, limited liability limited partnerships, for profit corporations, nonprofit corporations, benefit corporations, and limited liability companies. The term “S corporation” refers to a method of federal income tax applicable to an entity under the Internal Revenue Code. After forming your entity under state law you must then decide the federal income tax method you want to apply to your entity. If Homer Simpson forms a for profit corporation in Arizona and an Arizona LLC, he can cause both entities to be taxed under Subchapter S of the Internal Revenue Code by timely filing an IRS form 2553. The federal income tax law applies exactly the same to the corporation and the LLC taxed as S corporations.
P.S. Timely filing the IRS Form 2553 means filing the form with the IRS within the first two and one half months of the entity’s existence or within the first two and one half months after the beginning of a calendar year.
For more on this topic see my article called “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?“
Question: How do I convert my corporation into a limited liability company?
Answer: Two ways – the easy way and the hard, but not too hard way.
Easy Way: If your corporation does not have assets that have substantial value or contracts that cannot be assigned or transferred to the LLC without the consent of the other party to the contract then simply form a new LLC, dissolve the corporation and start doing business under the new LLC. If your corporation is an Arizona corporation and you dissolve it before or concurrently with forming your Arizona LLC the new LLC’s name can be identical to the corporation’s name.
Harder Way: Form an Arizona LLC and merge the corporation into the LLC. The advantage of this method is that a merger causes the assets and liabilities of the corporation to become assets and liabilities of the LLC automatically as of the effective date of the merger. If the dissolution of the corporation would cause its shareholders to pay unwanted income taxes the merger method may avoid the tax.
Example 1: World Wide Widgets, Inc. owns property that has a value of $101,000. The sole shareholder’s basis in his stock of the corporation is $1,000. If the corporation assigned the property to its shareholder before dissolving the shareholder would have taxable gain of $100,000 ($101,000 value of property – $1,000 adjusted basis of the stock).
If the stock is a capital asset (held for more than one year) the shareholder in this case could be paying as much as 23.8% of the gain as federal income tax plus state income tax if the shareholder resides in a state that has a state income tax. Arizona’s tax rate for capital gains in 2016 is 4.5%. Therefore, if the shareholder is an Arizona resident and the stock is a capital asset the total federal and Arizona income tax on the $100,00 gain is $24,500 if the shareholder is not subject to the 3.8% federal surtax on net investment income or $28,300 if the shareholder is subject to the surtax. Yikes! Who wants to pay federal and state income tax if it can be avoided.
The good news is that if the corporation is taxed as an S corporation or a C corporation and the LLC is taxed as an S corporation or a C corporation the merger can be a tax free reorganization under Section 368(a)(1)(F) of the Internal Revenue Code. By carrying out the “F” merger the shareholder can eliminate the income tax.
Example 2: Same facts as example 1 except the corporation taxed as a C or an S corporation merges into an LLC taxed as a C or an S corporation. Result: $0 income tax instead of $24,500 or $28,300.
Conclusion: Ask your CPA to tell you in writing what would be the income tax consequences to you if you were to dissolve your corporation. If dissolution will cause you to pay federal and/or state income tax you do not want to pay then do an F reorganization, i.e. merge your corporation into an LLC that is taxed as a C or S corporation.
P.S. If your surviving LLC will be an Arizona LLC hire me, Richard Keyt to prepare the merger documents and to consummate the tax-free merger. Call me at 480-664-7478 if you have questions or to get started.
Question: I am not a citizen or resident of the United States who wants to form a U.S. limited liability company. Can I get a federal employer identification number (EIN) for my LLC and if so, how?
“Apply by telephone—option available to international applicants only. If you have NO legal residence, principal place of business, or principal office or agency in the U.S. or U.S. possessions, you may call 267-941-1099 (not a toll-free number), 6:00 a.m. to 11:00 p.m. (Eastern time), Monday through Friday, to obtain an EIN. The person making the call must be authorized to receive the EIN and answer questions concerning Form SS-4.
Note. It will be helpful to complete Form SS-4 before contacting the IRS. An IRS representative will use the information from Form SS-4 to establish your account and assign you an EIN. Write the number you’re given on the upper right corner of the form and sign and date it. Keep this copy for your records.
Apply by fax. Under the Fax-TIN program, you can receive your EIN by fax generally within 4 business days. Complete and fax Form SS-4 to the IRS using the appropriate fax number listed in Where To File or Fax, later. A long-distance charge to callers outside of the local calling area will apply. Fax-TIN numbers can only be used to apply for an EIN. The numbers may change without notice. Fax-TIN is available 24 hours a day, 7 days a week. Be sure to provide your fax number so the IRS can fax the EIN back to you.”
Question: We discussed forming an LLC, but I’ve had some people recently tell me that I should create a C Corporation instead of an LLC. They said that the C Corporation gives the best tax advantages. I read on your website, that “Arizona recognizes that corporations may be formed for profit or not-for-profit, but not as C or S corporations.” So maybe what I’m hearing from these other people is that they are in other states and their laws are different from Arizona law regarding C corporations?
Answer: If a person tells you that you should form a C corporation you should run away as fast as possible because that person doesn’t know what he or she is talking about. No state in the U.S. has something called a C corporation. All states have for profit corps and nonprofit corps. The term C corporation refers to one of four methods of income tax under the Internal Revenue Code of 1986. The person that says form a C corp or form an S corp is confusing the type of entity formed under state law with the method of federal income tax under the Internal Revenue Code.
There is something in the Internal Revenue Code called subchapter S, which provides for how an entity that elects to be taxed under subchapter S is taxed. There is another subchapter called subchapter C, which provides how entities taxed under that chapter are taxed.
Before you form an entity the first question is what type of entity should you form under the law of a particular state. The types of entities are LLCs, LPs, LLPs, LLLPs, general partnerships, for profit corps and nonprofit corps. In Arizona, the LLC replaced the for profit corporation as the best entity to form. For an in depth discussion of whether to form a corporation or a limited liability company in Arizona to operate a business see my article called, “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?”
After you form the entity under the law of the chosen state the next question is how should the entity be taxed? An LLC can be taxed as a C corporation under subchapter C by filing an IRS Form 8832 with the IRS. When the LLC files the Form 8832 you can then say the LLC is taxed as a C corporation, but the entity remains an LLC.
To learn more about the four ways an LLC can be taxed read KEYTLaw attorney and former CPA Richard C. Keyt’s article called “How are LLCs Taxed?“
Question: I am a not a U.S. citizen and I live outside the U.S., aka a “nonresident alien.” I formed a limited liability company in the U.S. How do I get a federal employer id number (EIN) for my LLC?
Answer: You can get the EIN one of two ways: the easy way or the not so easy way. Before January of 2014 we could get an EIN for an LLC we formed for a nonresident alien if the nonresident alien completed and signed an IRS form SS-4 that designated my legal assistant as a third party designee authorized to contact the IRS and get the EIN. My legal assistant would call the IRS international EIN number, fax the SS-4 to the IRS agent and spend about 45 minutes on the phone, but at the end of the call the IRS would give my legal assistant the EIN.
Beginning in January of 2014, the IRS canned that procedure. Now a company of any type owned by a nonresident alien gets an EIN for the company by one of the following two methods:
You should be able to get the EIN for the new LLC by using the IRS’ online wizard here:
Easy Way: If the nonresident alien has an IRS issued International Taxpayer Identification Number (ITIN), the nonresident alien can obtain the EIN in a 5 – 10 minute data entry session using the IRS’ online EIN wizard. After submitting all of the information the website will display the EIN. Be sure to print the page with the EIN and keep it in a safe place.
Hard Way: If the nonresident alien does not have an ITIN then he or she must complete and sign an IRS form SS-4 and fax or mail it to the IRS. Faxing the SS-4 to the IRS is the better method because the IRS will fax the EIN to the applicant in approximately four business days vs. three to four weeks if the SS-4 is mailed to the IRS. Prepare, sign and fax the IRS form SS-4 to the IRS at 859-669-5760.
To get a partially completed IRS form SS-4 for an LLC and my detailed instructions on how to fill out the form read my article called “How to Complete IRS Form SS-4.” Be sure to delete all the text at the bottom of the form in the Third Party Designee Fields and insert your name, phone number and fax number at the bottom of the form.
Question: I operate my business through a limited liability company that is taxed as a sole proprietorship. I received an IRS Form W-9 from a vendor who wants my LLC’s employer ID number or my social security number. How do I complete the W-9?
Answer: Here is how you complete the beginning of IRS Form W-9:
- Enter your name in the “Name (as shown on your income tax return)” box.
- Enter the name of your LLC in the “Business name/disregarded entity name, if different from above” box.
- Check the box in the “Check appropriate box for federal tax classification:” box that is to the left of “Individual/sole proprietor.”
- In Part I enter your social security account number.
- Complete the remainder of the form then date and sign it.
The above assumes you did not file either an IRS Form 9932 or 2553 with the IRS to cause the LLC to be taxed as a C corporation or an S corporation, respectively.
Who Signs the IRS Form 2553 If My Confidential Trust Owns My LLC that Wants to be Taxed as an S Corporation?
Question: I purchased your Gold LLC formation package that included a Confidential Trust. My Confidential Trust is the sole owner of my LLC. My CPA advised me that my LLC should be taxed as an S corporation. I am completing the IRS Form 2553, Election by a Small Business Corporation, but I am not sure how to show the ownership and who should sign the form. What should I do?
Answer: Dealing with the IRS with respect to your LLC is different from everybody else. The following only applies to the IRS and tax treatment of your LLC that is owned solely by your Confidential Trust:
- Because the LLC is a single owner LLC the IRS pretends like it does not exist. The IRS calls a single member LLC a “disregarded entity” for federal income tax purposes. This is the default tax treatment for single member LLCs.
- Because the Confidential Trust is revocable the IRS treats it as a “grantor trust,” which means the IRS pretends like the Confidential Trust does not exist.
- The end result of the application of items 1 & 2 above is the IRS considers you to be the owner.
- Sign the IRS Form 2553 on page 2 Part 1 and after your signature put a comma and print the following text: “individually and as Trustee of the [name of your trust] Trust under Agreement dated [date of your trust agreement], a grantor trust.”
- If you are a resident of a community property state like Arizona and own the beneficial interest in the Confidential Trust as community property then both spouses must sign the Form 2553 per the instructions in item 4 above.
Send the completed and signed IRS Form 2553 to the IRS via Certified Mail, Return Receipt Requested. Make a transmittal letter that accompanies the Form 2553. Keep a copy of the letter, the Form 2553, the Certified Mail certificate and the green Return Receipt in a save place in case the IRS claims it never got your Form 2553.