Financial
Statement & Tax Return
Considerations For
Limited Liability Companies
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- Legal Forms is pleased to make these continuing legal education materials available to you. However, please note that
while still quite useful, portions of the materials discuss issues which have
been clarified by the "check_a_box" and other regulations subsequently
adopted by the Internal Revenue Service. Thus, the materials, as set forth,
should not be relied upon as reflecting the current state of the law and great
care should be used to ensure that all legal references and all conclusions
reached are still correct and have not been rendered obsolete by statutes,
regulations, rulings and other pronouncements of the Internal Revenue Service,
the courts, and various state agencies.
Use
of these materials
are subject to the terms of our
Cautions & Warranties
which may be found at www.proguide.com
I. To prepare tax returns or financial statements for
an LLC or its members, the preparer should
first
establish whether the entity actually was
created
and whether it is a member managed or
manager
managed LLC.
A. Obtain copies of at
least the following:
1.
Articles of Organization
2.
Operating Agreement, if any
a.
If none, get a representation to that
effect
3.
Other agreements existing between the
members
B.
Note whether there are any payments required to
be made to or from any members - eg.
additional
contributions or declared distributions.
C.
Note how the "value" of each member's interest
which is required to be maintained in the
records compares with those of the other
members.
See how profit and loss allocations
compare with the relative "value" of each
member and ascertain the basis for
substantially different allocations.
D.
If the "value" is substantially different than
those on the books, ascertain whether a IRC
754
election can or should be made.
II. Additional information should also be obtained which
will assist in determining the tax
classification of
the entity for federal and state tax
purposes:
A.
Private Letter Ruling from IRS
B.
Opinion of Legal Counsel
C.
Other agreements between the members regarding
voting, control, options to purchase,
approval
of continuation, and anything else
pertaining
to the transfer of the interests, or
continuity
of
life, or centralized management
1.
Ascertain who all the members are and what
their relationship is to each other - is
there control or a family relationship?
If the entity is taxed as a corporation,
appropriate
returns must be filed and tax liabilities
accrued.
III. Ascertain how LLCs and their members
are taxed in
all of the states in which the LLC operates.
A. determine if there
is any entity level tax due
B.
ascertain that state's rules regarding the
sourcing
of income
C.
ascertain whether there has been or should be
any withholding
D.
accrue any entity level tax liability
E.
if the member must pay the tax and the member
is the client, accrue the proper liabilities
IV. Ascertain the nature of the businesses in which the
LLC is engaged and the level of
participation which
each
member has with regard to the activity.
Consider how they impact on:
A.
passive loss rule considerations
B.
treatment as a tax shelter, farm syndicate, or
other
syndicate
1.
may not be able to use cash method of
accounting for tax purposes
a.
remember, you can not change methods
of
accounting without consent of the
IRS even if changing from an
incorrect to a correct method
2.
status as a limited partner, general
partner,
or limited entrepreneur
V. Ascertain what states the LLC operates in and
whether those states have LLC statutes.
1.
If there is a state in which the LLC
operates
which does not have an LLC
statute, ascertain whether anything has
occurred which might give rise to a
material or unusual liability
VI. Consider a financial statement disclosure regarding:
A.
the entity's or member's obligation to pay
taxes
B.
anticipated or acknowledged withdrawals needed
to pay taxes or other items
C.
any actual withdrawals since the balance sheet
date
D.
significant differences between book and tax
accounting income - regardless
of who pays the
tax
1.
consider disclosing deferred taxes
E.
significant differences in value of assets on
books and adjusted basis in assets for tax
purposes
1.
ascertain whether any special IRC 704(c)
allocation must be made because of a
contribution of property having a basis
which is lower than fair market value
F.
member equity; consider proper labels; consider
whether any difference in descriptions would
be
helpful if the LLC issued certificates
G.
manager members' investments
H.
interests held by unapproved assignees
I.
any change in the tax status of the entity
VII. If the entity, which is now an LLC, was
converted
from a partnership or other form of entity,
consider:
A.
APB 20 regarding the restatement of financial
statements -- changes in the legal form of
the
entity do not ordinarily permit or require
the
restatement of the financial statements.
1.
The format of comparative statements may,
however, need to be changed to allow more
meaningful comparison.
a.
such changes should be disclosed.
B.
disclosing the change in the legal form of the
entity
VIII. Financial Statement Presentation of the
Investment In An LLC
A.
An investment in an LLC will effect the balance
sheet of the investor.
B.
GAAP requires that minority investments in
corporations be reflected equity method of
accounting
1.
This method reflects the net investment in
the entity in which the investment has
been made
a.
amount is adjusted up or down
depending upon the profitability of
the investment
(1) impact
on financial statement is
usually not significant
C.
If investor has sufficient ownership interests
in a corporation (usually greater than 50%
of
the votes), consolidated financial
statements
are required and the equity method is not
used.
1.
all of the assets and liabilities of the
related entity are shown on the balance
sheet
of investing entity.
a.
reflecting assets and liabilities in
this way can impact cause a
significant impact on financial
ratios
(1) could
adversely affect bank
loans
(2) could
adversely licensing -eg.
Department
of Ag. milk buyer
requirements.
D.
Because LLC's are new, proper method is
uncertain.
1.
May be effected by member managed status
or manager managed status and level of
actual control if member managed but
subject to a binding contractual agreement
not
to exercise management rights.
2.
Also note, in some situations general
partners must report partnership recourse
liabilities
a.
this adversely impacts the general
partner's balance sheet
b.
use of an LLC can prevent inclusion
of these liabilities
IX. Miscellaneous Observations & Reminders
A.
Note that a change in the "value" of the
member's relative values in the entity, as
shown in
the records required to be kept has
several effects.
Some of them are:
1.
if there is no operating agreement, the
change affects the voting rights of the
members, profit and loss allocations,
distribution and liquidation rights.
a.
Thus, changes can have the affect of
shifting capital of the entity and
changing the allocable share of each
member's debt.
For tax purposes,
gain or loss may be realized and
recognized
as a result of such
shifts.
B.
Some Portions of the Wisconsin LLC Statute
Directly Pertaining to Accountants are:
1.
183.0607, Limitations on Distribution,
provides that there are limitations on
distributions from an LLC under
circumstances where the LLC will be
insolvent,
etc. The statute provides
specifically that:
(2) A LLC may base a determination that a
distribution is not prohibited by sub. (1)
on any of the following:
(a) Financial statements and other
financial data prepared on the basis
of accounting practices and
principles that are reasonable under
the circumstances.
So accountant should make sure statement
is sufficiently clear to avoid confusion
and potential negligence resulting in a
wrongful distribution.
2. Wis.
Stat.183.0706(2) & 183.0405,
pertaining to an assignee's becoming a
member and being liable for all of the
debts of the assignor to the extent that
they
were ascertainable from the records
required t be maintained by the LLC -
which includes financial statements.
a.
Accountants must make sure that
financials are complete, including
disclosures, or that limitations
apply and that they should not be
relied upon.
b.
If non-disclosed liability exists,
accountant may get in middle of the
fight between the assignee and the
LLC over
what should have been known
or disclosed.
X. Audit Letters and Attorneys Responses
A.
Accountants, through there standard audit
letter, will seek disclosure of facts from
accountants regarding the tax classification
of
the entity as well as information pertaining
to
many of the other issues set forth above.
B.
Attorneys, on the other hand, will not wish to
disclose the information, if it is not
generally known, because disclosure may
cause
the loss of the attorney-client privilege.
Furthermore, disclosure, while in the
accountants best interest, may not be in the
best interest so the client.
C.
While this conflict exists with regard to all
kinds of issues on a regular basis, the
factual
nature of some of the inquiries and the
uncertain law will require more than average
cooperation
between accountants and attorneys
if the client's need are to be served and
their
rights protected.
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