Client One
Tony Stark has had a bad day. As Iron Man he was defeated by Batroc ze Lepair (he's French, talks funny and is essentially a joke villain, hence Tony's depression). Tony has decided he needs help and has agreed to form a partnership with Bruce Banner and Frank Castle called "Avenge This".
As he is usually loaded (financially and otherwise) he will bankroll most of the operation. He will have a 70% capital interest, Bruce 20% (he has some income from inventions developed during his calmer moments-it's not easy being green) and Frank will get 10% (he spends all of his money on equipment as he keeps breaking things-after all he is the 'Punisher'.
They will allocate 45% of the income based upon capital accounts.
The balance of the profits will be allocated based upon services (super-heroing is very labor intensive). The big hitters, Tony and Bruce will each get 40% and Frank 20% (of the remaining 55% of the profits). However, Tony is in a high tax bracket and has asked that the cost recovery deductions be allocated solely to him. Bruce and Frank agree. Both are in low tax brackets, Bruce has a large medical deduction for tranquilizers and Frank spends 90% of his income on ammunition (mostly to fend off fans who have seen his movies).
Despite their initial contributions, they will have to borrow some capital. Tony believes they can get financing on their headquarters with a qualified non-recourse loan, but that the equipment financing may have to be recourse-Frank claims he would persuade the bank otherwise and Bruce, getting upset, rumbles something about 'smashing through red tape'.
Tony has deep pockets but knows Bruce has anger issues and can spread destruction when capturing super-villains. He suggests maybe they could form a LLC instead.
Tony knows he can't deduct in excess of basis and that debt is sometimes counted as part of that. But, will there be a difference in how he is treated between a partnership and a LLC, and why? (He hasn't got a budget together yet, so you won't be able to calculate exact figures, he just needs to know what the issues would be).
What advice do you give them? Do you need any additional information for your opinion? If so, what do you need to know and why?
Client Two
In the afternoon, Ben Grimm comes to see you. Ben and his brother, Reilly, had formed "It's Clobberin' Time LLC" (taxed as a partnership) several years ago to provide superheroes with emotional problems an outlet (clients include Wolverine, Frank Castle and Bruce Banner [who has had aggression issues for years]).
Reilly advanced the financing as the facilities and 'clobberable' equipment is a material element of the operation, Ben the 'celebrity' status. Both he and Reilly provided significant services. Reilly owned a 40% interest and Ben 60%.
However, on August 1 (2011) Ben gave his daughter, Trudy, a 20% interest. Trudy is in school and does not work at the LLC.
The IRS is auditing last year's "partnership" return for the year ending 7/31/2012, questioning two things:
(1) Reilly died on September 15, 2012. While Ben and Reilly are on a calendar year for tax purposes, the LLC is on a fiscal year (yes, it was IRS approved, even Ben can't clobber Uncle Sam) ending July 31. Ben is Reilly's beneficiary and executor, but Reilly's estate is still in administration.
a. Ben included Reilly's share of the profits for the 7/31/2012 fiscal year on Reilly's Form 1040 for 2012. This is Reilly's final 1040.
b. Ben plans to put all of Reilly's share of the income for the current fiscal year ending this July (7/31/2013) on the estate's 2013 1041 (the tax return for the estate, which is also on a calendar year). The agreement provides that a deceased partner's estate will get a distributive share for the year of death.
c. The IRS agent said something about 'closing' the tax year but Ben is pretty sure that isn't right-there will still be two partners (Ben and Trudy) after Reilly died and Reilly only owned 40% (Ben was told by his old accountant that it took a 50% withdrawal to terminate a partnership for tax purposes).
Is Ben right? How should this be reported and why?
(2) Ben had allocated the income for the 7/31/2012 return, 40% to Reilly, 40% to him and 20% to Trudy, according to their agreement.
a. The LLC had a profit of $165,000. Income for the year was allocated $66,000 to Reilly and $66,000 to Ben and $33,000 to Trudy.
b. The agent said that Reilly's services were worth $40,000 and Ben's $35,000.
c. He proposed to reallocate $10,000 from Trudy to Reilly and $5,000 from Trudy to Ben.
Ben (turning a bright orange) asks, "what is that Agent talking about?"
What should each of them really report for the 7/31/2012 fiscal year of the LLC?