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:

  1. 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.
  2. 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.
  3. The end result of the application of items 1 & 2 above is the IRS considers you to be the owner.
  4. 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.”
  5. 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.

2017-02-25T10:36:53-07:00February 8th, 2014|FAQs, How Do I, Tax Issues|0 Comments

Consequences of S Corporation Tax Method Termination

Question:  My multimember LLC filed an election to be taxed under Subchapter S of the Internal Revenue Code, aka S corp method of federal income tax.  Recently one of the members transferred 10% of the LLC to his corporation, which caused the IRS to terminate the S corp tax method.  Our LLC is now taxed as a partnership.  Do the other members of the LLC have a claim for damages against the member who caused the termination of the S corp tax method?

Answer:  It depends.  If the loss of the S corp election causes economic harm to the other members they could sue for damages, but it would be a roll of the dice as to who would win.  The defendant member’s defense would be “I was free to transfer my membership interest and never promised to refrain from doing anything that would cause the loss of the S corp tax method.”

If your LLC was formed by me then the Company and the other members would have a claim against the transferring member for breach of contract because every Operating Agreement I prepare contains a clause that says no member will take any action that would cause the LLC to lose its S corporation tax method, but it a member did cause the loss that member would be liable to the other members for damages.

My Operating Agreements also contain language that prohibits a member from transferring all or a  portion of the member’s membership interest without the consent of a majority of the members.

Caution about S Corp Method of Tax

To be eligible to be taxed as an S corporation none of the LLC’s owners can be a corporation, LLC (unless it is a disregarded entity), limited partnership, limited liability limited partnership, limited liability partnership or a nonresident alien.  If a qualified party ever becomes a member of the LLC it causes an automatic termination of the S corporation tax method as of the date the disqualified party acquires the membership interest.  This is the reason all multimember LLCs taxed as S corporations must have language in their Operating Agreements that prohibit transfers of membership interests without the approval of the other members.

Moral of the story:  Every multimember LLC needs a good Operating Agreement prepared by an LLC attorney who knows the LLC law of the state in which the LLC is formed.

2013-09-13T08:45:17-07:00September 13th, 2013|FAQs, Operating LLCs, Tax Issues|0 Comments

Tax Consequences of Break-Ups of Entities Taxed as Partnerships

For those of you who are tax nerds (like me and my son LLC attorney and former CPA Richard C. Keyt) here is a new article that will keep you on the edge of your seat.  Many LLCs are taxed as partnerships and are subject to the same federal income tax rules as partnerships.  The article is “Tax Consequences of Partnership Break-Ups: A Primer on Partnership Sales and Liquidations.”  Here is the abstract:

This Article is a practical exploration of the tax consequences of the alternatives for reducing a partner’s interest: by sale or by a liquidation distribution. Partnerships and limited liability companies do not last forever. Indeed, there comes a point in the life of many partnerships when it is time to retire or to eliminate the interest of one or more partners. There are essentially two forms of transactions for reducing or terminating the interest of a partner: a sale of the partner’s interest to another partner or a third party or a distribution from the partnership in liquidation of the partner’s interest. In some cases the economic effect of a sale or distribution will be the same. The binary nature of this choice, however, is deceptively simple. The variable tax consequences inherent in sales and liquidations of a partner’s interest raise some of the most complex issues in tax law that involve both technical and numerical challenges. In addition, although these issues arise at the reduction or termination of an interest, planning at the formation of a partnership is critical to resolution of questions about the termination of a partner’s interest. With examples, the Article is an attempt to guide the practitioner through an analysis of the statutory and regulatory rules affecting the taxation of sales and liquidation of a partner’s interest looking at the tax consequences to both the partners and the partnership. Although the Article is not an attempt to achieve the impossible — simplifying the excruciatingly complex analysis — the article tries to provide an analytical foundation for the myriad of difficult questions that arise on the context of removing a partner’s interest.

2015-11-01T09:01:09-07:00August 16th, 2013|Tax Issues|0 Comments

Did IRS Try to Kill IRA LLCs?

Yesterday two people sent me email messages asking if I had heard about the IRS trying to prevent people from using IRA money to make nontraditional investments through a limited liability company that is owned by the IRA custodian.  I learned that the source of their questions was an article called “If You Have An IRA, You Need To Know This.”  What follows is my response to the questioners:

You are the second person today and the second person ever to ask the question posed in your email.  I have not heard of the IRS prohibiting EINs for SMLLCs.  Here’s what the IRS says on its website:

“Q. Are any entity types excluded from applying for an EIN over the Internet?

A.  No. All customers whose principal business, office or agency, or legal residence (in the case of an individual) is located in the United States or in one of the U.S. Territories can apply for an EIN online. The principal officer, general partner, grantor, owner, trustor etc. must have a valid Taxpayer Identification Number (Social Security Number, Employer Identification Number, or Individual Taxpayer Identification Number) in order to use the online application.”

See Online EIN Frequently Asked Questions.

Sounds like the IRS doesn’t know it can’t issue and EIN to a SMLLC.  I called the EIN phone number at (800) 829-4933 to ask about this issue, but the wait was over 30 minutes.  I suggest you call that number and see what the IRS person says about it.  If you find any evidence that there is a new rule, please let me know.

If anybody has information about an actual denial of an EIN to an IRA LLC or an IRS official statement on this topic, please let me know.

Update:  The following is the contents of an email message I got from a nice CPA who took the time to call the IRS, wait on hold and speak to an actual person about the issue raised above:

After 1 hr and 55 minutes I got through to the IRS. They know of no announcement prohibiting the TIN division from issuing TIN numbers to single member IRA owned LLC”s.  In fact they were ready to start the process on the phone. I believe we can search through our tax service to try to locate any recent announcements regarding this issue.  I believe they are numbered.

Larry Wayne, CPA
Wayne, Gaynor, Umanoff, LLP
6100 Center Drive – Suite 950
Los Angeles, CA 90045
Tel  (310) 846-5770 Ext. 228
Fax (310) 846-5771

2017-10-06T21:42:14-07:00August 8th, 2013|Tax Issues|0 Comments

Taxpayer Victory in U.S. Tax Court Blesses New Way to Transfer Family Buiness

Wall St. Journal:  “Small-business owners often complain of feeling caught in the cross hairs of the tax code. For a change, here’s good news.  The Tax Court has just blessed a new technique that owners of closely held businesses—and wealthy families—can use to pass assets to heirs with a minimum of taxes and complications. The ruling in the case, Wandry v. Commissioner, is stirring up excitement among experts.”

The taxpayers owned a limited liability company worth approximately $1 million dollars.  In 2004 they created a plan by which they would make gifts each year of membership interests in the LLC to their children and grandchildren.  Their gift plan provided that at no time could an annual gift to a donee exceed the then amount of the U.S. gift tax exemption (currently $,3,000).  The court ruled that because of the method the taxpayers used to make the gifts it was not possible for any gift to ever exceed the amount gift tax exclusion amount therefor no gift tax was owed.

P.S.  The taxpayers plan included a clause that provided that to the extent any gift ever exceeded the annual gift tax exclusion amount the excess over the exclusion amount would go to a charity rather than the donee.  This type of clause gives the IRS no reason to challenge the taxpayers action because even if the IRS were successful on its claim the excess gift amount would go to the charity and the taxpayers would be entitled to a corresponding charitable deduction.

2018-10-07T10:39:24-07:00April 30th, 2012|Tax Issues|0 Comments

Can a Single Member LLC be Taxed as a Partnership?

Question:  Can a single member limited liability company be taxed as a partnership for federal income tax purposes?

Answer:  No.  The following text from the IRS’ website answers the question:

“Over the years, there has been confusion regarding Single Member Limited Liability Companies in general and specifically, how they can report and pay employment taxes.

An LLC is an entity created by state statute. The IRS uses tax entity classification, which allows the LLC to be taxed as a corporation, partnership, or sole proprietor, depending on elections made by the LLC and the number of members. An LLC is always classified under federal law as one of these types of taxable entities.

A multi-member LLC can be either a partnership or a corporation, including an S corporation. To be treated as a corporation, an LLC has to file Form Form 8832, Entity Classification Election (PDF), and elect to be taxed as a corporation. A multi-member LLC that does not so elect will be classified under federal law as a partnership.

A single member LLC (SMLLC) can be either a corporation or a single member “disregarded entity.”  Again, to be treated under federal law as a corporation, the SMLLC has to file Form 8832 and elect to be classified as a corporation. An SMLLC that does not elect to be a corporation will be classified by the existing federal guidance as a “disregarded entity” which is taxed as a sole proprietor for income tax purposes.”

IRS Form 8832 is the form used by an entity to elect a method of federal income taxation that is different from the IRS’ default method (sole proprietorship or disregarded entity for single members LLCs and partnership for multi-member LLCs).  This form is also known as the “check the box” form because an entity can elect a tax method by checking the box on the form.  IRS Form 8832, question 3 reads:

Does the eligible entity have more than one owner?

Yes. You can elect to be classified as a partnership or an association taxable as a corporation.

No. You can elect to be classified as an association taxable as a corporation or to be disregarded as a separate entity.”

See the IRS article called “Single Member Limited Liability Companies.”

2017-10-07T07:32:40-07:00September 24th, 2011|FAQs, Tax Issues|0 Comments

How Much Compensation must an Entity Taxed as an S Corporation Pay to Owners to Keep the IRS Happy?

The Tax Advisor:  “S corporation shareholders [and owners of LLCs taxed as S corporations] generally prefer dividend distributions of their S corporations’ [or LLC’s] profits over compensation payments from the S corporations [LLCs] because the compensation payments are subject to payroll taxes and dividend distributions are not. To prevent S corporations and their shareholders from avoiding payroll taxes by maximizing distributions and minimizing compensation payments, the IRS requires S corporations to pay shareholders who provide substantial services reasonable compensation. Disputes between the IRS and taxpayers have required courts to determine on a regular basis whether an S corporation has paid reasonable compensation to its shareholder(s).

2018-05-22T19:06:15-07:00August 23rd, 2011|Tax Issues|0 Comments

Lessons to be Learned from Sheriff Joe’s Bad Example

Maricopa County Sheriff Joe Arpaio and his wife formed an Arizona limited liability company in December of 2010 called “Ava Investments, LLC.”  In June of 2011 they transferred eight parcels of land into Ava Investments, LLC.

Apparently Joe and Ava were not concerned about confidentiality because their home address is listed in the Articles of Organization and on the Arizona Corporation Commission’s website as well as their names.  I can’t fault Sheriff Joe, however because he didn’t have a chance to read my article called “The Confidential LLC – How to Form an Arizona LLC without Disclosing Its Ultimate Owner(s)” because the article was written after the Arpaios formed Ava Investments, LLC.

Lesson 1:  If you want to keep your ownership of an Arizona limited liability company confidential and not on public display, do not be a member or manager of an Arizona LLC or use your home address for any purpose in the LLC’s Articles of Organization.

Apparently the purpose of Ava Investments, LLC, is to hold the Arpaio’s investment real estate.  I searched the Maricopa County Recorder’s website for Ava Investments, LLC, and found the following deeds:

  • June 6, 2011, Special Warranty Deed recorded on June 14, 2011, was signed by Joe and Ava as grantors conveying two parcels of land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Ava Investments Corporation, not Joe and Ava, (ii) the sales price was $75,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is for commercial or industrial use.”  The signature on the Affidavit appears to be that of Ava Arpaio who acknowledged that she was “duly sworn on oath . . . that the foregoing statement is a true and correct of the facts pertaining to the transfer of the above described property.”  These two parcels are located at 10635 & 10637 North 71st Place, Scottsdale, Arizona.  Problems:  The price listed is $75,00, but the deed transferred two parcels.  What is the price of each parcel?  Is $75,000 the total price?  Who was the seller?  The deed was signed by the Arpaios, not Ava Investment Corporation.  The Affidavit of Value states that the seller was the corporation.  If the property is/was owned by the corporation then the deed signed by the Arpaios did not transfer the title to the LLC.
  • June 6, 2011, Special Warranty Deed recorded on June 15, 2011, was signed by Joe and Ava as grantors conveying land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Joe and Ava, (ii) the sales price was $60,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is for commercial or industrial use.”  The signature on the Affidavit appears to be that of Ava Arpaio.  This property is located at 10614 North 71st Place, Scottsdale, Arizona.
  • June 6, 2011, Special Warranty Deed recorded on June 15, 2011, was signed by Ava Investment Corporation as grantor conveying land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Ava Investment Corporation, (ii) the sales price was $75,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is for commercial or industrial use.”  The signature on the Affidavit appears to be that of Ava Arpaio.  This property is located at 10610 North 71st Place, Scottsdale, Arizona.
  • June 6, 2011, Special Warranty Deed recorded on June 15, 2011, was signed by Ava Investment Corporation as grantor conveying land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Ava Investment Corporation, (ii) the sales price was $325,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is for commercial or industrial use.”  The signature on the Affidavit appears to be that of Ava Arpaio.  This property is located at 16733 East Palisades Blvd., Fountain Hills, Arizona.
  • June 6, 2011, Special Warranty Deed recorded on June 15, 2011, was signed by Joe and Ava as grantors conveying land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Joe and Ava, (ii) the sales price was $75,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is for commercial or industrial use.”  The signature on the Affidavit appears to be that of Ava Arpaio.  This property is located at 10632 North 71st Place, Scottsdale, Arizona.
  • June 6, 2011, Special Warranty Deed recorded on June 15, 2011, was signed by Ava Investment Corporation as grantor conveying land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Ava Investment Corporation, (ii) the sales price was $325,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is a single family residence and used for commercial or industrial use.”  Note:  The Affidavit says to check only one box to indicate the type of property, but two boxes were checked.  The signature on the Affidavit appears to be that of Ava Arpaio.  This property is located at 16743 East Palisades Blvd., Fountain Hills, Arizona.
  • June 6, 2011, Special Warranty Deed recorded on June 15, 2011, was signed by Joe and Ava as grantors conveying land to Ava Investments, LLC.  The Affidavit of Value recorded with this deed says that: (i) the seller was Joe and Ava, (ii) the sales price was $60,000, (iii) the method of financing was “exchange or trade,” and (iv) the property is for commercial or industrial use.”  The signature on the Affidavit appears to be that of Ava Arpaio.  This property is located at 10630 North 71st Place, Scottsdale, Arizona.

Lesson 2Diversity – do not put all of your eggs or assets in one basket.  We all know what happens when you drop your basket, you lose all of your eggs or real estate if you have all of your real estate eggs in one basket.  The Arpaios have 8 parcels of real property in one LLC.  If somebody gets killed or injured on one property and there is a large lawsuit against the LLC, all the properties could be lost.  For maximum asset protection, put each parcel of real estate in a separate LLC so in the worst case scenario, you only lose the equity you have in that one LLC.  Do not put multiple parcels of valuable real estate in the same limited liability company because you could lose everything if something goes wrong with one of the properties.  For more on this topic see my article called “How Many LLCs Should I Form for My Properties?

The paper trail raises some interesting issues that everybody who transfers land into an LLC should consider before making the transfer.

Lesson 3Always Consider Income Tax Consequences When Transferring Property.  The total purchase price of all the properties stated on the Affidavits of Value is $995,000.  The Affidavits of Value indicate that all the transfers involved an exchange or trade to satisfy the purchase price.  Therefore the newly formed Ava Investments, LLC, must have been funded with property valued at $995,000 that was used to exchange or trade with the sellers of the properties.  Did the Arpaios fund their LLC with a loan of property or make capital contributions of property valued at $995,000.  If the latter, the LLC’s basis in the property would be a carry over basis.  Would the exchange / trade be a taxable transaction?  Income tax law (Internal Revenue Code Section 1031) does provide for tax-free exchanges of real estate for real estate, but not real estate for personal property or money.  It is possible that one or more of the transactions could have created taxable events for buyer and seller.  Hopefully the Arpaio’s consulted with an experienced tax advisor before they consummated the transfers and taken steps to eliminate or mimimize any adverse income tax consequences.

Lesson 4Document & Track the Tax Basis of the Property Going into the LLC.  The LLC should document the income tax basis of property it acquires so it can deduct the basis from any amount realized on a later sale of the property.  If the LLC buys the property from the seller for its fair market value then the tax basis of the purchased property is the amount paid to acquire the property.  If the property is contributed to the LLC by a member, the LLC takes the same tax basis in the property that the member had in the property.

Lesson 5Document the Affect the Contribution of the Property to an LLC Has with respect to the Contributing Member’s Capital Account.  This is especially important when the LLC is a multi-member LLC other than a two member husband and wife LLC.  If a member contributes money or property to a multi-member LLC, the member’s capital account should be increased by the amount of money contributed or the value of the property contributed.  This is an important concept for multi-member LLCs.  Documenting or failing to document the value of members’ contributions added or not added to a their capital account has real economic consequences to the all the members.  All of the members should sign a document in which they agree to the value of contributed property and the amount that will be added to the contributing member’s capital account.  Think of a member’s capital account as similar to a bank account.  If you contribute real estate to a multi-member LLC that has $50,000 of equity, you want your capital account to increase by $50,000 because for every dollar that does not get credited to your capital account you will lose $1 or real money at some time in the future.

Lesson 6How Do You Determine Property Values?  It is unusual for two parcels of real estate to have the same value.  The purchase price of two of the parcels was $60,000, three parcels were priced at $75,000 and two were $325,000.  What a co-inky-dink!  How did the Arpaios determine the values of the properties?

See “Sheriff Joe Arpaio and His Fiesta Bowl Freebie.”

Should I Form an Arizona C Corporation or an S Corporation?

Question:  Should I form an Arizona C corporation or an S corporation?

Answer:  I form for profit corporations, nonprofit corporations, limited liability companies, and limited partnerships.  I’ve formed 7,600+ LLCs since 2001.  However, I do not form C corporations or S corporations because Arizona corporate law does not recognize or care about C corporation or S corporations.   Those two terms describe one of four methods of federal income tax applicable to entities. Nobody forms S or C corporations in the United States. People form:

  • for profit corporations (obsolete in Arizona except for limited circumstances)
  • nonprofit corporations
  • limited liability companies (most popular entity in Arizona)
  • limited partnerships (obsolete in Arizona except for limited circumstances)
  • general partnerships (never ever form a general partnership because every partner is 100% liable for everything that goes wrong)
  • sole proprietorships (never ever operate a business this way because the owner is 100% liable for everything that goes wrong)
  • business trusts (rarely used and not appropriate in Arizona)

The first four types of entities are formed pursuant to the statutory law of each state. No state in the U.S. allows for the formation of a C or an S corporation, both of which are methods of taxing an entity under the federal income tax code.

Before forming an entity, the first question is in what state should I form the entity? The second question is what type of entity should I form? After you form the entity, the next question is how should the entity be taxed for federal income tax purposes?

If you form a corporation, it can be taxed two ways:

  • C corp – the default method, or
  • S corp – if the corp is eligible to be an S corp and all of the owners sign and submit an IRS form 2553 to the IRS before the deadline.

If you form a limited liability company, it can be taxed four ways:

  • C corp
  • S corp
  • Partnership if it has two or more owners
  • Sole proprietorship if it has one owner or a husband and wife owners who own the company as community property

One of the many reasons Arizonans are forming LLCs 12 times more often than corporations is because of the four methods of tax available to the LLC vs. the two methods of tax available to a corporation.

I recommend that as soon as possible after forming your entity, but not later than 75 days, you talk to your tax advisor to determine which method of tax is best for you and the entity.

I do form for profit corporations when there is a good reason to do so or if I cannot convince my client that the Arizona LLC is a much better entity than the Arizona for profit corporation. To date, I have formed 7,600+ Arizona LLCs.

For an in depth discussion of whether to form a corporation or a limited liability company in Arizona to operate a business or hold real estate, see my article on my website called, “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?

See also my article called “If My New Business Will Have Start Up Losses, Should It be an LLC or an S Corporation?.”

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