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LAW REPORT
A Newsletter of the Tax & Corporate Practice Group FALL 2005
New Proposed Tax Regs Could Change Tax Disregarded Entities Now
Treatment of Partnership Interests Given
for Services Responsible for Employment
(CONTINUED FROM PAGE 1)
and Excise Tax Filings
value of all compensatory partnership interests as taxable
income. The Regulation then establishes a “safe harbor” BY RICHARD J. FLASTER
pursuant to which the value of a compensatory partnership
interest shall be equal to the “liquidation value of that interest.” Under existing rules, single-owner
Compare with In Re Hill’s Estate 193 F.2d 724 (2d. Cir. 1954). “disregarded entities” (such as single
Under the safe harbor, the value of a profits interest will neces- member LLCs or Qualified Subchapter S
sarily be zero, as the holder of such an interest is not entitled to Subsidiaries) were not responsible for
any capital upon liquidation. Essentially, this new safe harbor employment tax and excise tax obligations.
codifies the pre-existing rule with respect to “profits interests” Rather, the owners of such entities had
and eliminates the taxability of profits interests even where profits this responsibility.
are “substantially certain and predictable.” However, with the announcement of Proposed Regulations
The key significance of the safe harbor is that such treatment §307.7701-2(c)(2), the IRS seeks to treat the disregarded
must be elected by a partnership in order to be applicable. entity as the employer and to establish its responsibility for:
Moreover, Notice 2005-43, provides that upon adoption of the • Employment Taxes/Back-Up Withholding: Depositing
Regulation, Revenue Procedures 93-27 and 2001-43 will FICA, FUTA and income tax withholding with the IRS,
become obsolete. Therefore, if the election under Prop. Reg. filing 941 returns, and issuing W-2 forms.
1.83-3(l) is not made, the IRS can tax the grant of a compen- • Excise Taxes: Reporting and payment of applicable excise
satory partnership profits interest (after the date of adoption of taxes, registering as a buyer or seller in a transaction subject
the final Regulations). It is therefore crucial to understand the to excise taxation and claiming refunds and credits in
method for making the safe harbor election under Prop. Reg. such transactions.
1.83-3(l).
Observation: The new employment tax rules will take
Safe Harbor Election effect when the final regulations are issued. The new excise tax
rules will take effect for years beginning after January 1, 2006. ◆
The safe harbor election requires both a filing by the part-
nership and for certain provisions to be placed in the partner-
ship agreement.
First, the partnership must prepare a document, executed by
the partner who has responsibility for Federal income tax
reporting by the partnership (i.e., the Tax Matters Partner),
stating that the partnership is making this election (on behalf of
the partnership and each of its partners) to have the safe harbor
Automatic Extension for
apply irrevocably as of the stated effective date, and the docu-
ment must be attached to the tax return of the partnership for Filing 2005 Tax Returns
that year.
Second, the partnership agreement must contain the follow-
Increased to Six Months
ing provisions:
BY ALAN H. ZUCKERMAN
• The partnership is authorized and directed to elect the safe
harbor; and In the recently released version of
• The partnership and each of its partners agrees to comply Publication 509 (Tax Calendars for
with all requirements of the safe harbor with respect to all 2006), revised December 2005, the IRS
partnership interests transferred in connection with the per- announced that individuals filing 2005
formance of services while the election remains effective. If federal income tax returns (Form 1040)
the partnership agreement does not contain the required will be permitted to use Form 4868
provisions, each partner in the partnership must sign a sepa- (Application for Automatic Extension of
rate document containing those provisions. Time to File U.S. Individual Income tax Return) to obtain
an automatic six-month, rather than a four-month, extension.
Observation Individuals will not need to file Form 2688 to obtain the
additional two-month extension that was normally required
According to representatives of the IRS, Proposed Regulation
in order to obtain a total of a six-month extension. ◆
1.83-3(l) is expected to be finalized in June of 2006. ◆
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