Limited Liability Companies (or LLCs) were invented in Wyoming in 1977. They have since spread to all states and become one of the most popular entities to use for businesses. From a tax perspective, LLCs are hybrid entities that can elect to be taxed in a number of different ways. Regulations that became effective in 1997 (commonly referred to as the “check-the-box regulations”) provide tax classification. Treas. Reg. § 301.7701-1, et. seq.
Treas. Reg. § 301.7701-3(b)(1) describes the default treatment of LLCs where no check-the-box election is made. The default treatment of an LLC with a single owner is as an entity disregarded as separate from its owner for income tax purposes. Treas. Reg. § 301.7701-3(b)(1)(ii). As a disregarded entity, the LLC has no federal income tax filing requirements. Its activities (including income and loss) are instead reported on the tax return of its sole owner. Where an LLC has more than one owner, the default treatment is as a partnership. It is required to file an annual Form 1065 to report the pass-through income and loss allocated to its partners.
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Section 269(a) applies where a “person or persons acquire, directly or indirectly, control of a corporation” and “the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy.” Section 269 allows the IRS to disallow the acquired deduction, credit, or other tax benefit and to “distribute, apportion, or allocate gross income . . . between or among the corporations, or properties, or parts thereof, involved.” Control means at least 50 percent of the total voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of stock of the corporation.
Importantly, Section 269 does not apply to any acquisition for which tax benefits were a consideration, but only those where the principal purpose was tax benefits. Treas. Reg. § 1.269-3(a) defines principal purpose as where “the purpose to evade or avoid Federal income tax exceeds in importance any other purposes.” Thus, the tax benefit purpose must be the most important purpose for the acquisition, but it need not be the only purpose.
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I. Real Property Distributed from Testamentary Trust Meets the Section 1031 “Held for Investment” Requirement; PLR 202449007.
A testamentary trust terminated on the death of the decedent’s child. Real property held in the testamentary trust then passed to the decedent’s grandchildren. Prior to the trust termination, the trustees entered into a contract for the sale of the property and began to make arrangements for a deferred Section 1031 exchange of the property held in the trust. After the trust termination event, the trustees completed the sale of the property and sought a private letter ruling confirming the trust remainder beneficiaries (grandchildren of the decedent) would be permitted to complete like-kind exchanges as to their inherited real property.
The IRS ruled the trust’s previous purpose of holding the real property for investment purposes is imputed to the grandchildren notwithstanding the trustee’s planned sale at the time of the trust termination. The IRS emphasized, because the trust was a testamentary trust, the terminating event was fixed by the decedent and could not be modified or changed. The trust terminating event was an involuntary disposition of the trust’s real property. The transfer of the property to the grandchildren subject to the sales contract did not violate the held for investment requirement of Section 1031(a).
I. IRS Cannot Impose Tax on Withdrawals from an IRA It Seized; Hubbard v. Commissioner, 135 AFTR 2d 2025-484 (6th Cir).
Mr. Hubbard was a Kentucky pharmacist. He was convicted on drug and money laundering offenses for operating a pill mill. The court allowed the IRS to seize a number of Mr. Hubbard’s financial accounts, including his IRA. The IRS withdrew over $427,000 from the IRA. The IRS treated the IRA withdrawal as a taxable distribution to Mr. Hubbard and made an assessment against him of over $180,000 of tax, interest and penalties.
Courts have recognized two types of forfeitures. One is specific property forfeiture where the government becomes the new owner of specific assets at the time of conviction. The second type of forfeiture is a personal money judgment where the defendant is forced to pay a specific sum of money. With the second type of forfeiture, the court calculates the money that a defendant owes based on the value of forfeitable property involved in specific crimes.
Enacted in 2017, Section 1061 provides a minimum holding period of three years for long-term capital gains for carried interests issued to certain service providers. Section 1061 treats as short-term capital gain (generally taxed at ordinary rates) the portion of gain allocated to a service provider with respect to an applicable partnership interest that has not been held for more than three years. However, even if a service provider has held an applicable partnership interest for less than three years, capital gains allocated to the holder can qualify for long-term capital gains treatment if the asset sold by the partnership was held for more than three years. Also, Section 1061(a)(2) allows the service provider to take into account capital losses from assets held for more than three years.
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I hope this message finds you well. As we approach Memorial Day, I want to personally encourage you to attend the 24th Annual North Carolina Tax Section Workshop taking place Friday, May 23 to Sunday, May 25. This workshop is being held at the Kiawah Island Golf Resort and is an opportunity that promises not only high-quality continuing legal education but also meaningful connection with colleagues in our field.
Section 351(a) provides no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange such person or persons are in control (as defined in Section 368(c)) of the corporation. One of the requirements is the issuance of stock in connection with the transaction. However, the courts have found that in certain circumstances, the actual issuance of stock is not necessary.
A taxpayer’s relief from indebtedness is generally a taxable event. However, where Section 351 applies to a contribution of assets to a corporation for stock, the corporation’s assumption of liabilities may or may not be taxable under Section 357.
Section 357(a) states assumptions of indebtedness pursuant to a Section 351 transaction generally do not trigger gain. However, subsections (b) and (c) have important exceptions. Subsection 357(b)(1) provides where transfers are made either to avoid Federal income tax on the exchange or with no bona fide business purpose, the taxpayer is treated as if it received cash equal to the assumed debt. Section 357(b)(2) provides the burden is on the taxpayer to prove by the clear preponderance of the evidence that Section 357(b)(1) should not apply.
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Section 1361(b)(1) provides a corporation can qualify for taxation as an S corporation only if none of its owners are nonresident aliens, foreign entities, partnerships, corporations, or ineligible trusts. An S corporation shareholder generally must be a U.S. resident individual, but there are several exceptions.
Section 1361(b)(1)(B) allows decedent’s estates, eligible trusts, and certain charitable organizations to own S corporation stock. The trusts eligible to own S corporation stock include grantor trusts under Subpart E (which are disregarded as separate from their grantor for income tax purposes), electing small business trusts (ESBTs), certain voting trusts, and qualified subchapter S trusts (QSSTs). Trusts must have specified provisions and beneficial owners to be ESBTs or QSSTs.
Subject to the origin of the claim test, most judgments or settlements paid by a business are fully deductible as ordinary and necessary business expenses under Section 162(a). However, one exception is in Section 162(f), which provides “no deduction otherwise allowable shall be allowed under this chapter for any amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law.” This fine or penalty exception is defined broadly to include almost any payment made to a governmental plaintiff. It prevents a subsidy in the form of tax deductions for payments to governmental entities for violations of law.
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