Partnership Basis in Contributed Promissory Notes and Guarantees: Tax Tips

Date
Posted by
Philip Falco
Partnership Basis in Contributed Promissory Notes and Guarantees: Tax Tips

Your partnership must file a Beneficial Ownership Information Report with FinCEN.  We file those reports for $349.  Here is our page on that report.

Philip Falco, Attorney, CPA tracks inside and outside partnership basis, prepares 1065 Tax Returns and K1’s (303) 626-7000 phil@coloradolegal.com

Partners of a partnership sometimes contribute promissory notes to the partnership.  As an example, a partner drafts a note payable to the partnership promising to pay the partnership a sum of money.  The question then becomes whether the partner has an increase in partner basis for this.  The other question is what is the partnership’s basis in the promissory note.

Another related scenario is where a partner guarantees a partnership debt owed to a third party.  The question is whether this guarantee increases the basis of the partner in the partnership.

Partnerships don’t pay income tax, but they do file  information returns, and partners are supposed to use the numbers from those returns on their own individual returns. See IRC secs. 701, 6031, 6222(a).  Partnership basis is important because it determines where a distribution such as cash is taxed or not.  It also determines the amount of taxable gain or loss upon sale. An increase in a partner’s basis is desirable.  We provide legal and tax services to partnerships.

The value of what a partner contributes to his partnership can be tricky when he contributes something other than cash–like promissory notes or guarantees. a partnership’s basis in property contributed by a partner is the adjusted basis of that property in the hands of the contributing partner at the time of the contribution. IRC sec. 723.

The Tax Court has held that the contribution of a partner’s own note to his partnership isn’t the equivalent of a contribution of cash, and without more, it will not increase his basis in his partnership interest. See Dakotah Hills Offices Ltd. P’ship v. Commissioner, T.C. Memo. 1998-134, 75 T.C.M. (CCH) 2122.

As such, the partner’s basis does not increase and the partnership’s basis in the notes is zero.

However, a guarantee of a partnership debt to a third party does increase a partner’s basis.

For example, in Gefen v. Commissioner, 87 T.C. 1471 (1986) a partner executed a limited guaranty as a condition of her acquisition of an interest in a limited partnership. Under its terms, she assumed personal liability to the partnership’s existing creditor for her pro rata share of the partnership’s recourse indebtedness to that creditor. She also agreed that the partnership could
call on her to contribute to the partnership an amount equal to the partnership’s outstanding debt.  The Tax Court upheld the partner’s increase in basis for her limited guarantee.

This can be a tricky area.  However, here are tax tips:

  1. Consider guaranteeing a preexisting third party debt rather than contributing a promissory note to the partnership.
  2. Document that the partner is providing personal credit to partnership vendors.
  3. The partner should be obliged to make additional contributions under the guarantee.
  4. The guarantee must create a liability to a third party, not the partnership.

Nonresidents of Colorado Taxed on Colorado Real Estate

Date
Posted by
Philip Falco
Nonresidents of Colorado Taxed on Colorado Real Estate

It is a little known fact that if a nonresident of Colorado owns real estate in Colorado, such as a ski condo, the nonresident must file a DR 104 and complete the 104PN Part-Year/Nonresident Computation Form upon sale or receipt of rent.

For example, a taxpayer who lives in California and owns a vacation ski condo in Aspen must file a Colorado State Income Tax Return DR 104 upon the sale of the condo or if taxpayer has rental income with respect to the ski condo.  As such, taxpayer would likely file two State tax returns: a California return and a Colorado return.

In addition to Colorado real estate, the following income sources are taxed:

  1. The ownership of any interest in real or tangible personal property in Colorado
  2. A business, trade, profession, or occupation carried on in Colorado
  3. The distributive share of partnership or limited liability company income, gain, loss, and deduction determined under CRS section 39-22-203
  4. The share of estate or trust income, gain, loss, and deduction determined under CRS section 39-22-404
  5. Income from intangible personal property, including annuities, dividends, interest, and gains from the disposition of intangible personal property to the extent that such income is from property employed in a business, trade, profession, or occupation carried on in Colorado. A nonresident, other than a dealer holding property primarily for sale to customers in the ordinary course of his trade or business, shall not be deemed to carry on a business, trade, profession, or occupation in Colorado solely by reason of the purchase and sale of property for his own account.
  6. His share of subchapter S corporation income, gain, loss, credit, and deduction allocable or apportionable to Colorado.

 

Federal Taxation of Marijuana

Date
Posted by
Comments0
Philip Falco

The legalization of marijuana in Colorado poses fascinating federal tax challenges.  I will help the industry manage this challenge.

The problem lies in a short provision in the United States Tax Code.  As States, such as Colorado, legalize substances that are illegal under federal law, this section in the tax code provides a formidable barrier to business operations.  This section was enacted in 1982 when Ronald Reagan declared the “War on Drugs”.  As unambiguous as that war was so to it is this section of the internal revenue code.

Sidebar: I have always taken interest in the Tenth Amendment to the United States Constitution.  The Tenth Amendment is beyond the scope of this post.  In general, the Tenth Amendment is used by States as a legal mechanism to exert legal authority in its own right and thereby limit legal authority of the federal government.  The argument would go that if a State, such as Colorado, chooses to legalize a substance that is illegal under federal law, Colorado law prevails and preempts federal law.

Sidebar to the Sidebar: As a Coloradoan for the past 20 years, having first hand witness of the evolution of this business, it is headed in the right direction.  I base this solely on observation.  It has helped commercial real estate.  It does seem that it stimulated the commercial real estate market during the great recession.  Now that Colorado is regulating the industry, especially the City & County Denver, the industry appears more reasoned and is in its second stage. I would say it is very much in the growth cycle.

Taxation

I focus on the taxation of profits and business models.  A business model would not be sustainable if it were taxed 100% on revenue without the ability to take deductions.  Internal Revenue Code §280E does just that.

IRC §280E is a subsection to Part IX of the internal revenue code entitled Items Not Deductible .

IRC §280E provides:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

Marijuana is a schedule I controlled substance under federal law. As such no deductions or credits are allowed pursuant to IRC §280E.  Article XVIII, Section 16 of the Colorado Constitution legalizes marijuana for recreational use for individuals over 21 and regulation thereof.  Article XVIII, Section 14 of the Colorado Constitution legalizes marijuana for medicinal use.  Therein lies the rub.

Tax Court to the Rescue

Thank goodness for the separation of powers and level-headed judges.

Federal Taxation of Medical Marijuana / Caregiver Business Model

In a caregiver tax case, pursuant to IRC §280E the IRS disallowed all of Taxpayers deductions related to the provisioning of marijuana and deductions related to caregiving services.  The Tax Court disagreed.

The tax court allowed for Taxpayer to classify its business as two separate business models: provisioning of marijuana, and caregiver.  In the end, the tax court permitted most of taxpayer’s deductions.  The court permitted deductions related to caregiving such as rent, salaries, and so on.  The court allocated 10% of rent to provisioning of marijuana, which was disallowed.

What is interesting to note about this case is the IRS position of business-model pollution, as I describe it.  The IRS took the position that because Taxpayer was in a business concerning a controlled substance that business polluted the deductions of the legitimate business.  This concept of business-model pollution must be heeded as it applies to recreational marijuana.

Cost of Goods Sold

In a more recent tax court case, the court permitted the cost of good sold (COGS) deduction.  This is a huge win for the marijuana industry.

Gross income, as defined in IRC §61, does not include COGS.  Historically, accountants perform separate measurements of income.  At the very outset a measurement is calculated to determine gross revenues less COGS.  Tax law inherited this practice.  Tax law considers COGS an exclusion. When one studies accounting, as I have, he undertakes the study of Cost Accounting, which is in itself the science of COGS.

In this more recent case, the tax court implemented the notion of business-model pollution against Taxpayer that had the affect of disallowing deductions that otherwise would have been allowed.

Tax Planning

COGS provides a considerable tax planning strategy especially as it relates to the recreational industry.  Minimizing business-model pollution is critical to fortify the profit models of separate businesses as it possibly relates to grow and retail.

Published: July 16, 2014.

By: Philip Falco, Attorney, CPA

Tax Preparation and Planning for Entrepreneurs and High Net Worth Individuals

Date
Posted by
Philip Falco

Tax Preparation and Planning for Entrepreneurs and High Net Worth Individuals

During Tax season, we perform the most sophisticated tax preparation for you. We optimize shareholder and member basis, losses, gains, carryovers and carrybacks.  We ensure that you receive your deductions

Because we are vertically integrated, we provide you with simulated tax returns

If we find an error in your tax plan implementation, we bring it to your attention and provide our tax opinion.

We are vertically integrated.  To us this means that we start with the pieces that compose your tax return all the way up to strategic planning, legal planning, and integrate both for you.

After Tax Season
Tax season isn’t the only time to think about taxes. Nearly every business decision you make has a tax consequence, and we believe working with a tax professional year-round can help you make informed decisions to minimize tax liabilities and take advantage of every possible incentive.

It’s absolutely necessary to gain a thorough understanding of your company’s operations, tax elections and methods, not only to prepare an accurate, complete set of returns, but also to find the most effective means to save additional tax dollars and meet your financial objectives.

From implementing tax-saving strategies and reviewing new legislation to evaluating current elections and amending returns, our staff works tirelessly throughout the entire year to find the most effective ways to save you tax dollars and keep more of your hard-earned profits.

We are working on strategies to minimize the new Healthcare (ObamaCare) 3.8% Tax on Net Investment Income.  This tax is targeted at high income individuals (married filing jointly in excess of $250,000).

Click here to visit our Tax Preparation Page: Tax Preparation

Email us for a free consultation Phil@ColoradoLegal.com

Or call (303) 626-7000.

Commercial Real Estate holding entity

Date
Posted by
Philip Falco

Colorado Corporate entity selection is very important.

Setting off on the correct course at the very beginning is worth the investment.  It can save taxes, owner liability and headaches.

There are various types of entities under Colorado statute Title 7. Colorado was one of the first States to enact a Limited Liability Company (LLC) statute.  In fact, the author’s corporation class studied the Colorado LLC statute in 1993.

A Colorado LLC is the most popular Colorado entity and for good reason.

Its purpose is to provide limited liability to members.  Limited liability has dwindled somewhat by way of Colorado Case Law.  There are measures to take to ensure protection.

What is Limited Liability?  This refers to personal liability of a member for entity liabilities.  Entity liability could include liability from third-party personal injury.

There is the Limited Liability Partnership (LLP).

Under Colorado statute, there are several varieties of LLP.  Historically, an LLP was required to have at least one general partner.  An entity can now chose to be a Limited Liability Limited Partnership (LLLP).

There is the Colorado Corporation.

A Colorado Corporation is formed pursuant to C.R.S. §7-90-101, et. seq.  A great advantage of a corporation is its simplicity.

Taxation

Generally, an entity can be taxed as a partnership, a C-Corp (Double Tax), or an S-Corp (flow through).

A Real Estate holding entity usually would chose partnership taxation because of its flexibility.  Other entities chose S-Corp because S-Corps provide more clarity on payroll, and they do, which is very important for tax compliance.

Under the Check The Box regulations, an entity, such as an LLC, can chose the following tax classifications: C-Corp, S-Corp, Partnership.  Under certain rules, an entity is considered a disregarded entity for tax purposes, in which case, taxation is according to Sole Proprietorship rules.

Partners who are Married.

If there are only two partners and they are married, they might very well be considered a disregarded entity by the IRS.  This could throw a wrench in your tax paradigm, so check with a professional to be sure.