When an LLC/Partnership Needs Cash
The lending environment has required many partnerships to look to existing partners for cash. A partner’s initial thought may be to provide a loan to the partnership instead of contributing additional capital. Upon dissolution, a creditor tends to enjoy a preferred position ahead of partner capital. However, if there is risk, the partnership may default on the loan to the partner and the loan scenario may end up with a higher tax burden. When a partner converts a loan to capital at a time when the value of the partnership interest is less than the face value of the loan, cancellation of debt (COD) income occurs. The ordinary income from the cancellation increases the basis of the partner’s interest, which in turn may cause the partner to have a capital loss upon the partnership ceasing operations. If cash had been contributed as capital instead of a loan, ordinary losses may have offset capital and no COD income would be realized to offset the benefit of those losses. Accordingly, a partner is wise to consider whether to contribute capital, perhaps with a preferred return, instead of a loan.
Issuance of Warrants in an S Corporation Loan Restructuring
In Private Letter Ruling 201043015, the IRS ruled that warrants issued by an S corporation to a commercial lender in a debt restructuring did not constitute a second class of stock. The warrants entitled the lender to purchase a specific amount of non-voting common stock. The warrants were subject to various put and call rights which were effective prior to the exercise period for the warrants. The put and call rights were designed with the intention that the warrants would never be exercised, as the lender was an ineligible shareholder of an S corporation. The IRS ruled that the warrants fell within the exception provided in Regulation Section 1.1361-1(l)(4), as they were issued to a person that is actively and regularly engaged in the business of lending and issued in connection with a commercially reasonable loan to the S corporation.
IRS Provides Additional Section 118(a) Safe Harbors
Property contributed to a corporation by a governmental unit for the purpose of enabling the corporation to expand its operating facilities is generally considered a contribution of capital that is excluded from gross income under section 118(a). In these circumstances, when non-shareholder money is received as a contribution of capital, the corporation reduces the basis of its property, starting first with property acquired during the year of payment, followed by property placed in service in previous years. Now with the funding for certain energy and transportation grants made available pursuant to the American Recovery and Reinvestment Act of 2009 (ARRA), the IRS has provided safe harbors for several of these programs, and has agreed not to challenge a corporation's treatment of certain grants as a contribution to capital. Find out more about these safe harbors in our extended article, Section 118 Safe Harbors.
Energy Grant Program Extended
The recently signed Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the Energy Grant Program under section 1603 of the American Recovery and Reinvestment Act for one year through 2011. The popular program has helped fund a large number of renewable energy projects that would not otherwise have been possible and has been responsible for substantial job creation in the wind, solar, biomass and other renewable energy industries. According to the Department of Treasury's website, eligible properties “must be placed in service in 2009, 2010, or 2011, or placed in service after 2011 but only if construction of the property began during 2009, 2010 or 2011.” The corresponding credit termination dates remain the same. This change will provide substantial relief to businesses that have been rushing to document physical work on these projects or to meet the 5 percent project cost safe harbor in order to comply with the program’s requirement to begin construction by the end of 2010. The application deadline was also extended until Sept. 30, 2012.
Changes Expected to New Markets Tax Credit
On Dec. 9, Treasury Department Deputy Assistant Secretary Don Graves said that practitioners should expect significant changes to the section 45D New Markets Tax Credit (NMTC) program. The NMTC program was created to spur investment in low-income and other targeted communities. Graves said the program is “an absolute priority for Treasury and the administration.” That sentiment was reflected by the recent inclusion of the NMTC in the Obama tax compromise legislation, which extended the credit through 2011. According to Graves, Treasury is committed to reforming, extending, and broadening the credit. Moreover, the IRS 2010-2011 Priority Guidance Plan includes updating NMTC guidance, and issuing final regulations that clarify the rules relating to the recapture of the credit. Now that the credits have been extended through 2011, expect Treasury to make the 2010 award announcements soon. Donna Gambrell, director of the Treasury Department's Community Development Financial Institutions (CDFI) Fund, has said Treasury will make those announcements after legislation has passed.
Payroll Tax Cut for 2011
As part of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Congress slashed the Social Security tax rate from 6.2 to 4.2 percent. Millions of workers will see their take-home pay rise as a result of the tax cut. According to the IRS, this reduced Social Security withholding will have no effect on an employee’s future Social Security benefits. The Social Security wage base in 2011 is $106,800. It is important to note, the employer tax rate for Social Security remains unchanged at 6.2 percent. On Dec. 17, 2010, the IRS released Notice 1036 with more information on the changes in withholding. Employers should start using the new withholding tables and reducing Social Security tax withholding as soon as possible in 2011, but not later than Jan. 31. If Social Security tax is over-withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible, but not later than March 31, 2011. With the extra tax savings, some employers encourage their employees to increase their 401(k) contributions by 2 percent. It is money they weren’t expecting anyway, so why not have employees pay themselves by depositing their tax savings into their retirement accounts.