CorporateDIrect FullLogoWhiteLetter


Estate and Gift Tax Exemptions Increased for 2018

The Internal Revenue Service (IRS) just announced new rules for 2018.

First, the estate tax. In 2017, an individual could pass with $5.49 million in assets and not be subject to any federal estate tax. This amount is doubled for married individuals (or $10,980,000.) For 2018, this exemption amount has been increased to $5.6 million, or $11.2 million for marrieds. That is a lot of money to pass on tax free to your heirs. For context, in 1998 the estate tax exemption was only $625,000. The gift tax is assessed on gifts made during the year (as opposed to at your death). In 2017, an individual could gift $14,000 of assets to anyone without having to report the gift to the IRS on a tax return. There is no upper limit on the number of individuals you can gift money or assets to during your life. Grandpa Eddy can gift $14,000 this year to his ten grandchildren and get $140,000 out of his estate. For 2018, the gift tax exemption is $15,000. No gift tax return is required for gifts up to this amount. So now, Grandpa Eddy and Grandma Edna could each gift $15,000 to their 10 grandchildren and get $300,000 ($15,000 times 2 gifters times 10 grandchildren) out of their estate. Of course, with the estate tax exemption now at $11.2 million the need for couples to gift away assets during your lifetime to avoid a large estate tax at their death is somewhat diminished. One other tax change of note for 2018 is the Social Security wage base for computing payroll taxes. In 2017, this amount was $127,200. For 2018, it moves up to $128,400. Best wishes for the holidays and for a prosperous 2018!

Using LLCs to Hold Paper Assets

Many of our clients hold their stocks, bonds and other paper assets in the name of an LLC. If sued personally they will benefit from the charging order protections in strong states like Wyoming. Conversely, if they hold brokerage account(s) in their individual name a creditor can reach such accounts without a problem. Using an LLC to hold paper assets is good planning.

When transferring the brokerage account from your name to the LLC name there is no taxable event. You haven’t really “sold” your stock. You’ve just changed how the assets are held – from 100% you to 100% of a new LLC owned by you. This is done thousands of times all of the time without a problem or a whiff of taxation.

One Person is Fine – Joining Forces May be Taxing

But what if you and another person want to use the same LLC to hold your respective brokerage accounts? Wouldn’t it be cheaper to use one LLC instead of two?

You must be careful here. The savings of a few hundred dollars may be far outweighed by the taxation and complications of now being considered an investment company or investment partnership.

What follows is a fairly technical discussion of the applicable law. The short answer here is to only use one LLC for one person’s holdings. Joining together with two or more people can be taxing.

Husband and wife holding paper assets as jointly held or community property assets will be treated as one owner. But a husband and wife bringing separate property into one LLC can be counted as two persons and subject to the strict rules ahead.


Under federal law, 26 U.S.C. § 721, pertaining to “[n]onrecognition of gain or loss on contribution,” provides in relevant portion:


“No gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.


Subsection (a) shall not apply to gain realized on a transfer of property to a partnership which would be treated as an investment company (within the meaning of section 351) if the partnership were incorporated.”

In turn, 26 U.S.C. § 351, pertaining to “[t]ransfer to corporation controlled by transferor,” provides in relevant portion:


“No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.


“If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock permitted to be received under subsection (a), other property or money, then–

“(1) gain (if any) to such recipient shall be recognized, but not in excess of–

“(A) the amount of money received, plus

“(B) the fair market value of such other property received; and

“(2) no loss to such recipient shall be recognized.



“This section shall not apply to–


“A transfer of property to an investment company. For purposes of the preceding sentence, the determination of whether a company is an investment company shall be made–

“(A) by taking into account all stock and securities held by the company, and

“(B) by treating as stock and securities–

“(i) money,

“(ii) stocks and other equity interests in a corporation, evidences of indebtedness, options, forward or futures contracts, notional principal contracts and derivatives,

“(iii) any foreign currency,

“(iv) any interest in a real estate investment trust, a common trust fund, a regulated investment company, a publicly-traded partnership (as defined in section 7704(b)) or any other equity interest (other than in a corporation) which pursuant to its terms or any other arrangement is readily convertible into, or exchangeable for, any asset described in any preceding clause, this clause or clause (v) or (viii),

“(v) except to the extent provided in regulations prescribed by the Secretary, any interest in a precious metal, unless such metal is used or held in the active conduct of a trade or business after the contribution,

“(vi) except as otherwise provided in regulations prescribed by the Secretary, interests in any entity if substantially all of the assets of such entity consist (directly or indirectly) of any assets described in any preceding clause or clause (viii),

“(vii) to the extent provided in regulations prescribed by the Secretary, any interest in any entity not described in clause (vi), but only to the extent of the value of such interest that is attributable to assets listed in clauses (i) through (v) or clause (viii), or

“(viii) any other asset specified in regulations prescribed by the Secretary.
The Secretary may prescribe regulations that, under appropriate circumstances, treat any asset described in clauses (i) through (v) as not so listed.”

26 U.S.C. § 368(a)(2)(F)(ii) provides in relevant portion:

“(ii) A corporation meets the requirements of this clause if not more than 25 percent of the value of its total assets is invested in the stock and securities of any one issuer, and not more than 50 percent of the value of its total assets is invested in the stock and securities of 5 or fewer issuers. For purposes of this clause, all members of a controlled group of corporations (within the meaning of section 1563(a)) shall be treated as one issuer….”


Generally speaking, neither realized gain nor realized loss is recognized when property is contributed to a partnership in exchange for a partnership interest. See, 26 U.S.C. § 721(a). However, the general non-recognition rule contained in above-quoted 26 U.S.C. § 721(a) does not apply where gain is realized upon a contribution of property to an “investment partnership” and the contribution results, either directly or indirectly, in the diversification of the transferor’s interest. See, 26 U.S.C. § 721(b).

In turn, an “investment partnership” is defined by reference to the definition of an “investment company,” contained in 26 U.S.C. § 351(b). See, 26 U.S.C. § 721(b). The determination of whether a partnership is an “investment partnership” ordinarily is made by reference to the circumstances in existence immediately after the transfer; however, where circumstances change thereafter pursuant to a plan in existence at the time of the transfer, the determination is made by reference to the later circumstances. See, 26 C.F.R. 1.351-1(c)(2).

An “investment partnership” is a partnership in which more than 80 percent of the value of the assets of the partnership is from “stock and securities” that are “held for investment.” See, 26 U.S.C. § 721(b); 26 U.S.C. § 351(e)(1).

There is one significant difference between “investment partnerships” under 26 U.S.C. § 721(b) and “investment companies” under 26 U.S.C. § 351(e)(1): with “investment partnerships under 26 U.S.C. § 721(b), realized losses are not recognized. Thus, if a contributing partner contributes a portfolio of stock and securities, the amount of realized gain to be recognized is determined on an asset-by-asset basis, which may result in realized gains being recognized, even though there is a net loss on the portfolio of stock and securities when taken together. On the other hand, both realized gains and realized losses are recognized for transfers to “investment companies” under 26 U.S.C. § 351(e)(1).

According to the Secretary, a transfer ordinarily results in the diversification of the transferors’ interests if two or more persons transfer non-identical assets to a corporation in the exchange. However, if any transaction involves one or more transfers of non-identical assets which, taken in the aggregate, constitute an insignificant portion of the total value of assets transferred, such transfers are disregarded in determining whether diversification has occurred. See, 26 C.F.R. 1-351(c)(5). Similarly, if two or more persons transfer identical assets to a partnership, the transfer generally will not be treated as resulting in diversification.

Significantly, a transfer of stock and securities will not be treated as resulting in a diversification of the transferors’ interests if each transferor transfers a diversified portfolio of stock and securities. A portfolio of stock and securities is considered to be diversified if it satisfies the 25- and 50-percent tests of 26 U.S.C. § 368(a)(2)(F)(ii). See, 26 C.F.R. 1-351(c)(6).

In turn, 26 U.S.C. § 368(a)(2)(F)(ii) provides that a portfolio of stock and securities is considered to be diversified if not more than 25 percent of the value of its total assets is invested in the stock and securities of any one issuer, and not more than 50 percent of the value of its total assets is invested in the stock and securities of 5 or fewer issuers.

In Internal Revenue Service (IRS) Letter Ruling Number 200931042, released July 31, 2009, the IRS concluded that contributions of cash and/or a diversified portfolio of stocks in exchange for a partnership interest did not trigger the gain recognition rules applicable to “investment companies.”


Initially, it would appear that, if the LLC in question is being set up for the benefit of only one person, in order to hold only one person’s solitary brokerage account, then there would be no possibility of diversification whatsoever, and accordingly, there would be no possibility of only one person incurring adverse tax consequences as a result of the LLC in question being construed as an “investment partnership” under the provisions of 26 U.S.C. § 721(b) and 26 U.S.C. § 351(b).

On the other hand, if the LLC in question is being set up for the benefit of two or more persons, in order to hold two or more persons’ combined brokerage accounts, then it is entirely possible that, if these two or more persons contribute non-diversified portfolios, consisting of high concentrations of non-identical stock and securities, and/or assets from the other eight (8) proscribed asset classes set forth in 26 U.S.C. § 351(e)(1), then these two or more persons might well experience unexpected and highly undesirable tax consequences. For example, this situation easily might occur if more than 25 percent of the value of the LLC’s total assets were invested in the stock and securities of any one issuer, or if more than 50 percent of the value of the LLC’s total assets were invested in the stock and securities of five (5) or fewer issuers. Clearly, the latter scenario should be avoided at all costs.

On the other hand, if these two or more persons each contribute a diversified portfolio of “stock and securities” that satisfies the 25- and 50-percent tests of 26 U.S.C. § 368(a)(2)(F)(ii), then these two or more persons most likely will not experience any negative tax consequences. See, 26 C.F.R. 1-351(c)(6).

All things considered, it would be best if the LLC in question were being set up for the benefit of only one person, in order to hold only one person’s solitary brokerage account. That way, there would be no possibility whatsoever of diversification, and accordingly, no negative tax consequences as a result of the LLC in question being construed as an “investment partnership” under the provisions of 26 U.S.C. § 721(b) and 26 U.S.C. § 351(b).

That being said, with two or more persons, perhaps the safest and easiest way to avoid any negative tax consequences as a result of the LLC in question being construed as an “investment partnership” under the provisions of 26 U.S.C. § 721(b) and 26 U.S.C. § 351(b), is to avoid meeting the 80% test altogether, by having the LLC own real estate and/or other non-marketable securities that constitute more than 20% of the value (say 33% of the value) of the LLC at the time of the transfer.

26 U.S.C. § 721(b) and 26 U.S.C. § 351(b), together with their accompanying rules and regulations, are quite complex statutes, and they contain many counter-intuitive perils, pitfalls, and unintended consequences for the unwary. Thus, without careful tax planning, the contribution to an LLC by two or more persons of “stock and securities,” and/or assets from the other eight (8) proscribed asset classes set forth in 26 U.S.C. § 351(e)(1), might easily result in unexpected and highly undesirable gain recognition, if the LLC were to be construed as an “investment partnership.” If you want to go this route be certain to work with an experienced CPA or tax attorney.

Otherwise, don’t be penny wise and pound foolish. The safest course is to use one LLC to hold the paper assets of just one individual.

Lessons from a New York Court Case on Piercing the Corporate Veil

Some business owners and investors don’t understand the importance of keeping business and personal dealings separate, and can end up paying for it. Especially, when they are treating their business like their alter ego as was the case in this unfortunate New York court case. This can result in a lawsuit that pierces the corporate veil. If it’s not easy for a court to determine how a corporate entity is separate from the owners’ property, or other LLCs or corporations, all the related property could be used to pay for the result in a lawsuit. A tragic case in New York City illustrates the importance of using good business practices.

Do you remember the crane collapse on 91st Street in New York City? Two people died, and now two corporations have had their veils pierced to pay for the wrongful deaths.
The State of New York is quite willing to pierce the veil in certain cases. This was one of them.

In In re 91st Street Crane Collapse Litigation, 154 A.D.3d.139, 62 (1st Dept., decided Sept. 12, 2017), the survivors of a crane operator and a worker, both killed during the tragic crane collapse on May 30, 2008, brought wrongful death actions.

The defendants, New York Crane & Equipment Corp. (“N.Y. Crane”), J.F. Lomma, Inc. (“JF Lomma”), and James F. Lomma (“Lomma”) appealed from the first judgments in the plaintiffs’ favor, arguing among other things that the trial court erred in allowing the jury to pierce the corporate veils of N.Y. Crane and JF Lomma, and in subjecting Lomma to personal liability. The trial lasted nearly a year and 87 witnesses were called to testify.

The evidence established that N.Y. Crane and JF Lomma, both incorporated in Delaware, rented cranes, while a second corporation named JF Lomma, incorporated in New Jersey, trucked the cranes to and from customers. Most of the cranes rented out by defendants were owned by nonparty Lomma Corporation, JLJD, which leased them to other Lomma companies for sublease to customers. Lomma’s entities rented out each other’s equipment at will; actual ownership did not matter. Lomma would decide later how much one company should pay the other, and thus had the ability to shift profits between companies. Lomma signed blank DOB CD forms–the forms necessary for the registration of a crane for use at a particular construction site–so that the general manager could fill in which company was renting out which crane on any particular job. Although N.Y. Crane’s tax returns stated that all the company’s equipment was stored in Brooklyn, the various Lomma entities kept their equipment, including the crane involved in this accident, at a yard in New Jersey personally owned by Lomma. None of the Lomma companies paid rent for use of the yard, and JF Lomma (NJ) paid the taxes. All Lomma companies shared the same offices and email system, and there was overlap of management and administrative personnel. All senior management, including Lomma and in-house counsel, were paid by JF Lomma (NJ), and all salaried employees in the organization were paid through the web-based ADP payroll account of JF Lomma.

The crane at issue was purchased by N.Y. Crane, and then $500,000 in refurbishment was spent. Lomma testified that although JF Lomma paid for the crane bearings from RTR (a China-based distributor, which subcontracted work to factories in China), the amount was charged back to N.Y. Crane. However, no proof of that was presented. Repairs to the Kodiak’s turntable bearing in 2007 were made in New York and supervised by JF Lomma. JF Lomma also paid for all replacement and new crane bearings and received any applicable insurance proceeds.

The Decision in In re 91st Street Crane Collapse Litigation

With respect to N.Y. Crane and JF Lomma, the New York Supreme Court, concluded, based upon the above evidence, that there was sufficient evidence to permit the jury to pierce the corporate veils of N.Y. Crane and JF Lomma, and that the evidence supported the jury’s conclusion that the multiple Lomma corporations conducted business as a single entity.

With respect to Lomma personally, the Court noted that, contrary to Lomma’s arguments, plaintiffs presented substantial evidence of Lomma’s personal participation in the corporate defendants’ affirmatively tortious acts launching the dangerous instrumentality that caused the deaths of plaintiffs’ decedents. As such, the Court found that the evidence sufficiently established that this was more than what defendants asserted–that Lomma was simply “one person who is a shareholder, officer and director in two or more corporations.” The Court emphasized that this one individual exercised domination and control over three separate corporations which he treated as one entity. Based upon this evidence, the Court concluded that there was sufficient evidence to permit the jury to assess personal liability against Lomma.


New York law historically has allowed the corporate veil to be pierced either when there is fraud or when the corporation has been used as an alter ego. See, Itel Containers Int’l Corp. v. Atlanttrafik Exp. Serv. Ltd., 909 F.2d 698, 703 (2d Cir. 1990). In New York, the determinative factor in piercing the corporate veil under the alternative alter ego theory is whether the corporation is a “dummy” for its individual stockholders, who are, in reality carrying on the business in their personal capacities for purely personal reasons. See, Port Chester Elec. Const. Corp. v. Atlas, 40 N.Y.2d 652, 656-57, 389 N.Y.S.2d 327, 357 N.E.2d 983 (1976). Thus, under New York law, when a corporation has been so dominated by an individual or another corporation and its separate entity so ignored that it primarily transacts the dominator’s business instead of its own and can be called the other’s alter ego, the corporate form may be disregarded to achieve an equitable result. See, Austin Powder Co. vv. McCullough, 216 A.D.2d 825, 827, 628 N.Y.S.2d 855 (3rd Dept., 1995).

Furthermore, in New York, it is not necessary to plead or prove fraud in order to pierce the corporate veil under the alter ego theory. Wrongdoing in this context does not necessarily require allegations of actual fraud. While fraud certainly satisfies the wrongdoing requirement, other claims of inequity or malfeasance will also suffice. See, Baby Phat Holding Co., LLC v. Kellwood Co., 123 A.D.3d 405, 997 N.Y.S.2d 67 (1st Dept., 2014). Indeed, in Passalacqua Builders, Inc. v. Resnick Developers South, Inc., 933 F.2d 131, 140-41(2d Cir. 1991), the U.S. Court of Appeals for the Second Circuit held that it was error to instruct a jury that a plaintiff is required to prove fraud in order to pierce the corporate veil.

In applying the alternative alter ego theory, New York courts traditionally rely upon the following ten factors: (1) the absence of the formalities and paraphernalia that are part and parcel of the corporate existence, i.e., issuance of stock, election of directors, keeping of corporate records and the like; (2) inadequate capitalization; (3) whether funds are put in and taken out of the corporation for personal rather than corporate purposes; (4) overlap in ownership, officers, directors, and personnel; (5) common office space, address, and telephone numbers of corporate entities; (6) the amount of business discretion displayed by the allegedly dominated corporation; (7) whether the related corporations deal with the dominated corporation at arms length; (8) whether the corporations are treated as independent profit centers; (9) the payment or guarantee of debts of the dominated corporation by other corporations in the group; and (10) whether the corporation in question had property that was used by other of the corporations as if it were its own. See, Gateway I Group, Inc. v. Park Ave. Physicians, P.C., 62 A.D.3d 141, 146, 877 N.Y.S.2d 95 (2d Dept., 2009), quoting, Shisgal v. Brown, 21 A.D.3d 845, 848-49, 801 N.Y.S.2d 581 (1st Dept., 2005).

Therefore, the inescapable conclusion to be drawn from even a cursory examination of New York law with respect to piercing the corporate veil, is that the evidence relied upon by the New York Supreme Court, in In re 91st Street Crane Collapse Litigation in piercing the corporate veil, is in conformity with the factors traditionally relied upon by New York courts in piercing the corporate veil under the alternative alter ego theory.


In In re 91st Street Crane Collapse Litigation, the New York Supreme Court, simply applied the alternative alter ego theory under well-established New York law to the above facts.

Thus, the mere fact that the Court did not discuss fraud in its opinion is of little or no consequence to small business owners in New York or elsewhere. The Court’s decision appears to have been well in keeping with established New York precedent.

The significant “take away” from In re 91st Street Crane Collapse Litigation, is not that the Court did not discuss fraud in its opinion, but rather that New York, unlike some other jurisdictions, historically has allowed the corporate veil to be pierced either when there is fraud or when the corporation has been used as an alter ego.

It is very important to know the parameters of corporate law and to follow the formalities which establish those boundaries.

P.S. Not sure if your company is protecting you as it should? Get an evaluation by an expert. Get a Corporate Cleanup.

Do You Own California Real Estate? Courts Create New Tax for LLCs Holding Real Estate

Owners of LLCs Holding California Real Estate, Beware!

The State of California is at it again. A recent case decided by the California Supreme Court allows cities to asses Documentary Transfer Taxes like never before.

When property is transferred by a deed, counties and some cities can charge a transfer tax.

They have done so for over 150 years. In Los Angeles, for example, the transfer of a $1 million property results in a transfer tax of $5600. In San Francisco, a $5 million property transfer results in a $112,500 transfer tax. Although in many cases the tax is split between the buyers and sellers, the income for cities and counties is significant.

However, private transfers, where the deed was left intact and at no time transferred, were never taxed. An example of such a transaction would be where an LLC was on title to the property. The owners could sell their membership interests in the LLC and not pay a transfer tax. This was because the LLC was still on title, and thus no deeding occurred.

The case of 926 North Ardmore changed all this, resulting in higher taxes and many unanswered questions.

If you own California real estate you need to read the case summary below.


In 926 North Ardmore Avenue, LLC v. County of Los Angeles, 3 Cal.5th 319, 396 P.3d 1036, 219 Cal.Rptr.3d 795 (decided June 29, 2017), a single member limited liability company apartment building owner brought an action for a tax refund after it was required to pay a documentary transfer tax based on the value of the apartment building, when its single member partnership sold approximately 90% of its partnership interests to two trusts. The Superior Court, Los Angeles County, entered judgment for the County; the LLC appealed; and the California Court of Appeal affirmed. The California Supreme Court granted review, and in a 6-1 decision, held that: (1) a transfer tax is not a fee paid in connection with the recordation of deeds or other documents evidencing transfers of ownership of real property, but rather is an excise tax on the privilege of conveying real property by means of a written instrument; (2) that a written instrument conveying an interest in a legal entity that owns real property may be taxable under the Documentary Transfer Tax Act (“DTTA”), even if the instrument does not directly reference the real property and is not recorded; and (3) that the transfer is subject to the DTTA.

The Facts of 926 North Ardmore

Beryl and Gloria Averbook (the “Averbooks”) owned an apartment building at 926 North Ardmore Avenue in Los Angeles (the “Building”). They established a family trust and transferred the Building into it. Beryl died, and after his death, the family trust’s assets, including the Building, were transferred to an administrative trust maintained for Gloria’s benefit. Gloria’s two sons, Bruce and Allen Averbook, were named successor trustees, and they formed the following two entities: 926 North Ardmore Avenue, LLC (the “LLC”), a single-member limited liability company established to acquire and hold the Building; and BA Realty, LLLP, a partnership. The administrative trust was the sole member of the LLC. It also held a 99 percent partnership interest in BA Realty.

Initially, the administrative trust conveyed the Building by grant deed to the LLC. It then transferred its membership interest in the LLC to BA Realty, and divided its 99 percent interest in BA Realty and distributed it to four subtrusts also maintained for Gloria’s benefit. The survivor’s trust received 64.66 percent; the nonexempt marital trust 23.86 percent; the exempt marital trust 0.67 percent; and the bypass trust 9.81 percent. The net result of these transactions did not alter one central reality. When the Averbooks transferred the Building from themselves personally into the family trust, they retained a beneficial interest. The trust became the legal owner, but it was obligated to hold and manage the Building for their benefit. After Beryl’s death, Gloria held the sole beneficial interest. The subsequent transactions moved the Building’s legal ownership among the various entities. But Gloria’s beneficial interest remained unchanged.

Later, a different kind of transaction triggered imposition of the DTTA. The survivor’s trust, the nonexempt marital trust, and the marital trust transferred all of their interests in BA Realty to two trusts maintained for Bruce and Allen, who were each the sole beneficiary of their named trust. As a result, Bruce and Allen each acquired a beneficial interest in the Building they had not held before.

The later transfers were effectuated by written instruments, including six limited partner transfer and substitution agreements. The transaction did not involve the execution of a deed or other instrument transferring title to the Building. The agreements did not mention the Building or its location, nor were they recorded. After the transfers, Bruce’s and Allen’s trusts each held a 44.695 percent partnership interest in BA Realty, which was the sole member of the LLC, which, in turn, held legal title to the Building. In consideration for the transferred interests, Bruce’s and Allen’s trusts each executed promissory notes to Gloria’s three subtrusts. The amount paid by Bruce and Allen was based on an appraisal of the assets of BA Realty, including the Building.

The Majority Opinion in 926 North Ardmore

In a 6-1 decision, the Supreme Court of California noted that the DTTA permits the county to levy a tax “on each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers,” if “the consideration or value of the interest or property conveyed (exclusive of the value of any lien or encumbrance remaining thereon at the time of sale)” exceeds $100. The Court pointed out that documentary transfer tax is not a fee paid in connection with the recordation of deeds or other documents evidencing transfers of ownership of real property, but rather is an excise tax on the privilege of conveying real property by means of a written instrument.

As such, a written instrument conveying an interest in a legal entity that owns real property may be taxable under the DTTA, even if the instrument does not directly reference the real property and is not recorded. The Court observed that the critical factor in determining whether the documentary transfer tax may be imposed is whether there was a sale that resulted in a transfer of beneficial ownership of real property. Thus, the imposition of a documentary transfer tax is permitted whenever a transfer of an interest in a legal entity results in a change in ownership of real property through a change in a legal entity results in a change of ownership of real property, so long as there is a written instrument reflecting a sale of the property for consideration. The Court concluded that the Building owned by the LLC changed ownership when the partnership interests were transferred, and thus was subject to documentary transfer tax. The Court stated that the following approach would elevate form over substance and would conflict with the purposes of the DTTA:

“[I]f A executed a deed transferring real property to B, that deed would be taxable. But if A created a limited liability company, executed a deed transferring real property to that company, and then executed a written instrument transferring the company to B, the tax would not apply.”

Justice Kruger’s Lone Dissenting Opinion in 926 North Ardmore

Associate Justice Kruger disagreed with the majority opinion, and she wrote a strong dissenting opinion. In her dissenting opinion, Justice Kruger noted the absence of any precedent to justify application of the California DTTA to “run-of the mill transfers of interests in legal entities that happen to own real estate.”

In her view, the majority opinion finds no support either in the language of the DTTA or in “the over-150-year history of the documentary transfer tax.” Justice Kruger concluded that the existing California DTTA requires a direct transfer of real estate to trigger the transfer tax, and that it was the job of the California legislature, and not the job of the California courts, to decide whether the California DTTA should be expanded to transfers of entity interests:

“The majority’s expansion of the DTTA may or may not be a good idea, but it ventures well beyond the statute’s language and historical practice. I would leave it to the Legislature to determine the circumstances under which an entity interest transfer should result in a deemed sale of the entity’s real estate, and how to calculate the tax due in those circumstances.”


A number of California cities and counties, including, but not limited to, the City and County of San Francisco, Santa Clara County, and the City of Oakland, already have changed their ordinances to apply the DTTA to legal entity changes. In addition, Los Angeles County, the defendant in 926 North Ardmore, and other California cities and counties, have disclosed informally on their websites that the DTTA is due on legal entity changes. Most assuredly, other California cities and counties will apply the DTTA to legal entity changes.

The California Supreme Court’s decision in 926 North Ardmore raises a plethora of unanswered questions, such as: (1) Will the documentary transfer tax be imposed upon the buyers and sellers of the transferred entity interests, or upon the entity itself? (2) How will “value” be determined? (3) Will mergers, acquisitions, and restructuring transactions trigger a documentary transfer tax obligation for real property owned by the entities? (4) Will the documentary transfer tax be imposed upon the full value of the entity interests, or only upon the realty attributable to the transferred entity interests? (5) Will the holding in 926 North Ardmore be applied retroactively or prospectively only? (6) If so, then how far back can the cities and counties go? (7) Will penalties and interest apply? (8) Will taxpayers have to examine various internet websites to determine whether cities and counties will apply the DTTA to legal entity changes? and (9) Will cumulative transfers over time of more than 50% ownership of the entity interests trigger application of the DTTA?

Although no commentator has discussed or even mentioned the issue, it seems apparent that, if the California Supreme Court’s decision in 926 North Ardmore is applied retroactively, rather than prospectively only, then the big loser will be the Mortgage Electronic Registration System (MERS), which has been circumventing California cities and counties out of their documentary transfer tax fees for over two decades.


Once again, we see another tax grab by the State of California. Justice Kruger’s lone dissenting opinion basically “got it right.” There is no California precedent, either in the language of the DTTA or in “the over-150-year history of the documentary transfer tax,” to support the majority opinion in 926 North Ardmore. The existing California DTTA requires a direct transfer of real estate to trigger the transfer tax, and it is the job of the California legislature, and not the job of the California courts, to decide whether the California DTTA should be expanded to transfers of entity interests.

In any event, the California Supreme Court’s decision in 926 North Ardmore raises a plethora of unanswered questions that will not be decided for many years to come.

New IRS Rules for LLCs and LPs Require Amending Operating Agreements Immediately

The IRS has instituted new audit rules which require every LLC Operating Agreement and Limited Partnership (LP) Agreement to be amended. While we have never experienced such a dramatic requirement, it is important to make document amendments before December 31, 2017. The IRS likes to penalize non-compliance.

Why the big change? In the past, when the IRS audited an LLC or LP taxed as a partnership, they eventually had to interact with all of the LLC members or LP partners. (From here on we will just use the word ‘partner’.) Identifying and monitoring all the partners was a difficult task, especially in very complex, multi-tiered partnership structures (think oil and gas and real estate syndications.) Partners could intervene in the proceedings, complicate the audits and even litigate over them. As well, the IRS usually needed the agreement of every partner to settle the audit. You can imagine how difficult this would be in a sophisticated LP with 10,000 partners in seven separate tiers of rights. As well, even if the aggregate post audit tax obligation amount was large, the costs of collecting small amounts from (or getting refunds to) many partners was forbidding.

So you can kind of understand why the IRS would want to change the whole process. You would too in their shoes.

Immediate Action Required for LLCs and LPs

The new rules allow the IRS to deal directly with the LLC or LP. It is called the Centralized Partnership Audit Regime. Unlike the past, individual partners have no rights to receive notice, engage in the proceedings, or disagree with the result. A single Partnership Representative (who need not be a LP partner or LLC member) interacts with the IRS.

When the audit is finished, the IRS calculates an ‘inputed underpayment’ that the partnership owes the IRS. This will equal the understatement of income multiplied by the highest tax rate assessed during the year in question. By collecting directly from the partnership the IRS doesn’t have to track down and collect from individual partners through layers and layers of partnerships and entities.

It is the Partnership Representative who deals directly and exclusively with the IRS. An entity may be appointed to serve in this role, but an individual with a substantial presence in the United States also must be identified. In the eyes of the IRS the Partnership Representative has absolute authority to bind the partnership. Typically, an LLC Manager/Member or LP General Partner is listed, with the ability to later appoint a CPA or tax lawyer, if you desire, if an audit comes your way. If a Partnership Representative is not appointed in your operating document, the IRS may select anyone they want to serve in this key role.

This is why you want to promptly amend your documents to appoint yourself or someone else who is on your side as the Partnership Representative. You don’t want the IRS making this decision for you.

There are other new technical rules in place which will only be necessary to know if you are ever audited. The only other general rule of import is that some small partnerships may opt out of the new rules.

For reasons we shall discuss, opting out is not your best choice.

Who Can Opt Out of the New Rules?

Partnerships with less than 100 eligible partners may elect out of the new rules and stay with the old ones. Eligible partners include individuals, C corporations and S corporations (but each S corporation shareholder counts towards the 99 partner limit).

Single Member LLCs and Trusts Can’t Opt Out

Importantly, disregarded entities (i.e. single member LLC’s) and living – or revocable – trusts aren’t eligible partners. Virtually all of our clients use a mix of single member LLCs and living trusts for their combined asset protection and estate planning goals. Under the new rules, opting out is not allowed for such clients. Even if you opt out you must affirmatively opt out every year with the IRS, and provide the names and tax identification numbers of all partners. The burden of such annual reporting is greater, in our opinion, than just complying with the new rules.

It gets worse. If you opt out and a partner changes their ownership to a Wyoming LLC or your CPA doesn’t make the annual election, you are automatically back into the new rules. However, because you didn’t opt in, amend your agreement and appoint a Partnership Representative, the IRS gets to appoint one for you. This is not a good position to be in.

The IRS has made it clear what they think about opting out. From their website:

“To ensure that the election out rules are not used solely to frustrate IRS compliance efforts, the IRS intends to carefully review a partnership’s decision to elect out of the centralized partnership audit regime. This review will include analyzing whether the partnership has correctly identified all of its partners for federal income tax purposes notwithstanding who the partnership reports as its partners. For instance, the IRS will be reviewing the partnership’s partners to confirm that the partners are not nominees or agents for the beneficial owner.”

Again, these rules are aimed at large partnerships. In most cases, it doesn’t really make a difference whether an audit is done at the entity level or the partner level. In closely held entities they are really one and the same. There is no great burden to following the new rules. Indeed, they involve less ongoing IRS surveillance.

There are a number of new technical rules, which will only be necessary for you and your CPA to know if you are ever audited. The only other requirement to know is that if money is owed after an audit the IRS will collect from the partnership, or, if the 6226 election is made, from the existing partners. You could have a situation where partners who owed the tax in an Adjustment Year (i.e. 3 years ago) are no longer partners of the entity today.

We have added language in the amended agreements which allows the Manager or General Partner, in their discretion, to collect monies owed from previous partners. We have also included provisions in the transfer of ownership sections where the responsibility for any tax audit obligation is assigned.

It is helpful to know why the IRS (as authorized by Congress) made this change. As mentioned, the large and complicated master LP structures made it nearly impossible for the IRS to collect from individual partners. Audits of large partnerships were few. The new rules allow the IRS to deal with these entities. Large and complex partnerships are the target here – not smaller LLC and LP asset holding entities.

By amending your LLC Operating Agreement and/or LP Partnership Agreement, by designating a Partnership Representative, and by providing the IRS with accurate returns as you have always done, you will be fine.

13 Tips for Responding to IRS Notices

Contributed by Robert W. Wood, Tax Lawyer and Managing Partner with Wood LLP Everyone must pay federal income taxes. Yet exactly how much you owe, and on exactly how much, is famously complex. All tax returns must be signed under penalties of perjury. That means you have to do your best to report everything fully and honestly, but the grey areas are plentiful. For example, exactly when is something income, even though you physically don’t have it? What type of proceeds qualifies for long term capital gain rather than ordinary income rates? What losses are full write-offs, and which ones are limited to offsetting gains? What assets can be written off all at once, and what must be capitalized and written off ratably over many years? These and many other questions come up at tax return time. You must have some answers to be able to file, even if you are leaving many of the details to tax return preparers. But once you sign your name and file, what about the IRS notices that come? How should you react, and in what order? You can contest many IRS tax bills, although there are times not to. When you disagree with the IRS, procedure is important. You must pay attention to the order in which notices arrive and the specific ways in which you can respond.

Most Audits are Via Correspondence

Most audits do not involve sitting across the desk from an IRS agent. Let’s say you file your tax return and later receive a notice from the IRS saying it has information that you received $6,000 that you failed to report. It might be due to a Form 1099 you mislaid, one that failed to show up in the mail, or some other bit of information the IRS has that does not match your return. Usually such a notice will ask you to sign the form and mail it back if you agree. Alternatively, the notice will ask for an explanation of why the information is incorrect. You can contest it—if you do so promptly. You can also agree if the IRS is right.

 Don’t Fight Every Tax Bill

If you know the IRS is correct, don’t fight. Likewise, if the IRS is seeking a small amount of tax, you may be better off not fighting it, even if you are right. Just consider whether it is worth it if the dollars are small. Of course, what is a small tax bill can mean different things to different people. Sometimes, disputing something small can end up triggering other issues that might have best been left alone. So consider that too. In most cases, if you get a bill for additional taxes, you’ll want to preserve your rights. Timelines and procedure are critical.

Watch Out for Proposed Deficiencies

The notice described above is not a Notice of Proposed Deficiency. Still, you should answer it. An Examination Report may follow the first notice if you fail to respond. Most tax lawyers call the Examination Report and accompanying letter a “30-day letter.” It will say you have 30 days to respond in a so-called administrative “protest.” A protest is just a letter.

Make Sure You Prepare a Timely Protest

If you receive an IRS Examination Report, make sure you prepare a protest and sign and mail it before the deadline. Keep a copy for your records, and keep proof of mailing too, preferably certified mail to provide verification of mailing and of IRS receipt. Explain yourself thoroughly and attach documents where they will be helpful. Your protest should analyze the facts and the law. Put your best foot forward. The IRS may review your protest and agree with you. Even if they don’t, how you frame your protest can help later. If you have protested in a timely way, you will normally receive a response that the IRS is transferring your case to the IRS Appeals Division.

IRS Appeals Division is Nationwide

The IRS Appeals Division is a separate part of the IRS. Its mission statement is to resolve cases. By definition, these are cases in which the auditor has recommended additional taxes, and the taxpayer disagrees. The Appeals Officer assigned to your case works for the IRS, and in that sense, can never be truly unbiased. Even so, the IRS Appeals Office is separate, and they try to be impartial and, when they can, fair. This process of working out compromises works surprisingly well. A tax lawyer may be best qualified to handle your case, but an accountant can be equally qualified. Alternatively, you can do it yourself. Just be aware that while it is less expensive to do it yourself, it is also generally less effective. The vast majority of tax cases are resolved at Appeals. Usually, you’ll be assigned to the Appeals Office closest to you. Offices are throughout the U.S. and sometimes you are assigned to an Appeals Office in some far corner of the country. This is generally based on the workload of the offices and Appeals Officers. It can also be based on particular tax issues that some offices are handling. If that location doesn’t facilitate a face-to-face meeting and you want one, you can ask for the case to be moved to the IRS Appeals Office nearest you, nearest to your tax lawyer, your books and records, etc. The IRS is not required to grant such requests, but they usually do. Most IRS Appeals Officers are happy to get a case they are assigned off their desk and assigned to someone else!

Beware a Notice of Deficiency

If you fail to protest, or if you do not resolve your case at IRS Appeals, you’ll next receive an IRS Notice of Deficiency. An IRS Notice of Deficiency always comes via certified mail. It can’t come any other way. A Notice of Deficiency is often called a “90-day letter” by tax practitioners because you’ll have 90 days to respond. There used to be many flubs about exactly when that 90 days ran out. So today, the IRS is required to prominently display on page one of the Notice of Deficiency the actual deadline for your response. Don’t write the IRS to protest a Notice of Deficiency. In fact, only one response to a Notice of Deficiency is permitted: filing a Tax Court petition in the U.S. Tax Court clerk’s office in Washington, D.C. Although it is best to hire a tax lawyer, some taxpayers handle their Tax Court case on their own, pro se. There are special simplified procedures available to taxpayers who represent themselves in cases where less than $50,000 in tax is in dispute. Whether you are handling the case yourself or you hire a tax lawyer, the U.S. Tax Court cannot hear your case if you miss the 90-day deadline.

Tax Court Judges Travel to Your Area

The Tax Court building and clerks are all in Washington, D.C. However, the 19 Tax Court judges travel to federal courthouses all around the country to conduct trials. You can pick the city where you want your case to be heard when you file your Tax Court petition. Tax Court procedure and rules of evidence are streamlined, with no jury, and with relaxed rules of evidence. You can call witnesses, and many cases are presented based on a “stipulated record.” In it, you and the government agree on certain facts.

Your Case Can Go Back to IRS Appeals

Remember, the only way you can respond to a Notice of Deficiency is to file a timely petition in U.S. Tax Court. Fortunately, though, that doesn’t mean your case will necessarily be decided in court. An IRS lawyer will file an answer to your Tax Court petition. As with most other answers in litigation, the IRS will generally deny whatever your petition says. But then, you can ask the IRS lawyer to transfer your case to IRS Appeals. Often, a Notice of Deficiency is issued before a case has ever gone to IRS Appeals. In that sense, it can seem as if the IRS is trying to cut off your right to an Appeal. Actually, though, it is usually because of workload, or because the IRS is worried that the statute of limitations on the tax year in question is about to run. The IRS often issues a Notice of Deficiency to make sure you can’t later say the IRS is too late to assess taxes. When this happens, the IRS lawyer will almost always be happy to transfer your case to (or back to) IRS Appeals. This also ties into extensions of the IRS statute of limitations, below.

IRS Often Asks You to Extend the Statute

Often, the IRS says it is auditing you, but needs more time. Giving the IRS more time to audit you? It may sound counterintuitive–if not downright crazy to give the IRS more time, but it is not, as we will see. The IRS may ask you for an extension because they need more time to audit you. Your first reaction may be to relish the thought of telling the IRS absolutely not! Even a routine tax audit can be expensive and nerve-wracking. The IRS normally has three years to audit, measured from the return due date or filing date, whichever is later. But the three years is doubled in a number of cases. For example, the IRS gets six years if you omitted 25 percent or more of your income. Even worse, the IRS has no time limit if you never file a return, or if you skip certain key forms (for example if you have an offshore company but fail to file IRS Form 5471). You have to assume that if the IRS is asking you to extend the statute, the IRS is already monitoring you closely. And for the most part, people usually do voluntarily give the IRS more time to audit. Why would anyone do that? It works like this. The IRS contacts you (usually about two and a half years after you file), asking you to extend the statute. Most tax advisers say you should usually agree. If you say “no” or ignore the request, the IRS will assess extra taxes, usually based on an incomplete and quite unfavorable picture. You might think that you could fail to say yes or no and that the IRS might forget about you. But this is something the IRS is very careful about. The IRS rarely misses issuing a Notice of Deficiency, and you usually will be worse off (often much worse off) than if you agreed to the extension. There are exceptions to this rule, but relatively few. And sometimes you can agree to the extension but limit the extra time you give, or even the tax issues at stake. Get a professional to help you weigh your facts.

You Can Sometimes Get Extensions Too

Everyone knows there are automatic six-month extensions to filing your taxes. April 15 can become October 15, although you still must pay any taxes due by April 15. But what about extensions when the IRS demands a response to a notice or letter within 30 days? For many notices, the IRS will grant an extension of time to respond. In some cases, though, they can’t. For example, when you receive a Notice of Deficiency (90-day letter), you must file in Tax Court within 90 days, and this date cannot be extended. Most other notices are less strict. If you do ask the IRS for an extension, confirm it in writing, and keep a copy. In fact, confirm everything you do with the IRS in writing.

Some IRS Actions Can Be Undone.

It is always best to respond to IRS notices within their stated time frames. Still, it is sometimes possible to undo IRS action after the fact. For example, even after the IRS places a lien on property or levies on a bank account, this can be reversed. However, it is usually harder and more expensive to undo something, and it usually requires professional help.

You Can Pay Up, Then Sue

If you do not respond to a Notice of Deficiency within 90 days, and you have an assessment, all is not lost. You will not be able to go to Tax Court, but you can contest the taxes in federal district court or in the U.S. Claims Court. Usually you must pay the taxes first, and file a claim for refund. If the refund request is not granted, then you can sue for a refund. The primary advantage of proceeding in Tax Court is that you need not pay the tax first. In contrast, most taxpayer suits in U.S. District Court or U.S. Claims Court are after the tax has been paid. Sometimes, though, you can cleverly shoehorn yourself into one forum even though it might seem that you don’t satisfy the rules. Take the case of Colosimo v. U.S., 630 F.3d 749 (8th Cir. 2011). There, the IRS pursued the company and its owners for payroll taxes. The owners sued in District Court for a ruling they were not “responsible persons” required to pay the payroll taxes. But the owners paid only a fraction of the taxes the IRS was seeking. This was a clever use of the notion that sometimes you can pay only a portion of the tax due, with your suit resolve both pieces of the asserted tax: the part you paid, and the part you didn’t.

Be Careful

Remember, there are many different types of tax notices, even if you are only talking about the IRS. We have covered a few types of IRS notices here, including a Notice of Deficiency. However, there are many other types of important notices, including liens, levies and summonses. Forms of response vary, and procedure is important. You’re best advised to get some professional help. In general, don’t ignore anything you get from the IRS! Robert W. Wood is a tax lawyer with and the author of numerous tax books including Taxation of Damage Awards & Settlement Payments (  This discussion is not intended as legal advice.