Partnership Anti-Abuse Rules and Why They Matter For Your LLC
When you are deciding on a business entity, if you are looking for a flexible entity structure with more than one person, you probably ended up deciding on an LLC. At the time, you probably learned about the tax basics but it can be helpful to know a little bit more about how the tax law can affect the transactions and bookkeeping for your business.
Multiple member LLC’s are taxed as partnerships which means the taxation is governed by Subchapter K of the Internal Revenue Code. This section was created to allow for a simpler structure for partners to use when conducting business for profit without incurring an entity level tax. However, Congress did not really intend for these businesses to use the structure to avoid taxes. More specifically, they intended partnerships to only use tax allocations and transactions for true business purposes and not for businesses to use special allocations for tax avoidance. So what happened? Partnerships started using special allocations for tax avoidance and IRS implemented additional regulation to minimize that. IRS calls them anti-abuse rules. The anti-abuse regulations attempt to establish whether there truly is a substantial business purpose, and that the details of the transaction accurately reflect the parties’ economic position.
Anti-Abuse Rules
When looking at a partnership/multiple member LLC, IRS will use various factors to determine whether the arrangement is consistent with the intent of Subchapter K including the following:
· Presence of a “straw” partner or temporary partner;
· Familial relationship with partners;
· Is the current value of the partners’ tax substantially less as a partnership than without;
· Whether the present value of a partners’ tax substantially less than if separate transactions were combined;
· Tax items properly and consistently allocated across all regulation; and
· Whether the benefits and burdens of contributed property are substantially held by the contributing party.
Violations of Anti-Abuse Rules
Violations of the anti-abuse rules generally would involve the contribution of property to a partnership, or creation of a partnership for a tax benefit and little other actual reason. If IRS were to examine a transaction, or a partnership as a whole, and find it to run afoul of these rules, there are a number of potential outcomes. IRS could disregard the partnership in part or fully; it could reallocate tax items; or adjust claimed tax treatment.
What is the overall message here? When you are working with your advisors to start a partnership or engage in a transaction, you will always take into account the tax implications. So long as you are not shifting things around to distort the appearance of the deal for the tax implications and there is a real reason for the partnership existence or the transaction, you are probably okay. When evaluating the arrangements available, IRS expects you to select the one that seems most advantageous for tax purposes but you don’t want to choose an option that doesn’t otherwise fit with your deal. Your advisors should be able to help you through this but if you are ever unsure, you now have some information to be aware and ask questions.
This article is an overview of legal considerations and does not cover every legal right or obligation, consideration, exception, or restriction. Every business decision should be well researched and discussed with a professional before being made.
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