© 2014 Gray Reed & McGraw, P.C.The information contained herein is subject to change without notice

ECONOMIC AND TAX ISSUESIN DRAFTING PARTNERSHIP

AGREEMENTS

PART ONE: CHOICE OF ENTITYDan Kroll

Christopher MoralesAustin Carlson

January 28, 2015

Before We Begin

Highway to the Next Level

You

Professor Kroll

Next Tax Level

4

Objectives

Better understanding of the two main drivers for choice of entity:Liability PlanningTax Planning

Better understanding of why many investment structures are so complex.

5

Business Entity Choices

Corporation C Corporation S Corporation

REIT Tax Exempt

Partnership General Limited

LLP MLP

Limited Liability Company

Check the box flexibility

6

Non-Tax Considerations

Limited Liability for Owners Management

Corporation -- Board of Directors LLC -- Board of Managers or Managing Member/Sole

Member Limited Partnership -- General Partner General Partnership -- Managing Partner

7

Non-Tax Considerations

Ownership FlexibilityPreferred EquityJunior EquityEconomic WaterfallsProfits InterestsDisproportionate Distributions

8

Tax Considerations Double Tax v. Single Tax Losses Trapped in Entity Basis Increase to Owners for Entity Income Tax Basis to Owners for Entity Debt Flexible Allocation of Tax Items Taxable In Kind Distributions Tax-Free Merger Inside Basis Increase to Buyer Upon Equity Sale “Blocker” function

9

C Corporation

Double Tax Losses Trapped No Outside Basis Increase for Current Earnings In Kind Distributions Are Taxable Tax-Free Merger Possible

10

Double Tax Example

C Corporation

Non-Corporate Shareholder

Customer Expenses IRS

IRS$13

$65

$35$100$200

5

321

4

Revenue 200Expenses -100Net Income 100Less: 35% Corporate Tax -35After-Tax (Corporate) 65Less: 20% Dividend Tax -13To Shareholder After All Taxes 52

If the $65 of after-tax earnings are retained in the C Corporation, Shareholder's Tax Basis in the Shares does not increase

11

Single Tax Example

S Corporation or Partnership

Owners

Customer Expenses IRS

IRS$20

$100

$0$100$200

5

321

4

Revenue 200Expenses -100Net Income 100Less: Corporate Tax -0After-Tax (Corporate) 100Less: 20% Shareholder Tax -20Retained Earnings 80

Pass through entity distributes $100 to Owners Taxes; Owners pay $20 in tax, retain $80.

12

Trapped Losses

C Corp

Shareholder

Losses incurred by C Corp may not be used by the Shareholder

Loss Allocation

13

Corporate Reorganizations

Target Corp

TargetShareholder

s

Exchange of Target Shares for Acquisition Corp Shares are tax-free to Target Shareholders

Merger Sub

Acquisition Corp

Acquisition Corp

Shares

merger

14

S Corporation

Single Class of Stock Limited Number and Type of Shareholders No Allocation Flexibility Technical Election Procedures and Footfaults No basis allocation for Shareholder Debt In-Kind Distributions are Taxable No Disproportionate Distributions Allowed

But Redemption Safe Harbor

But, No Trapped Losses Basis Increase for Retained Operating Earnings

15

S Corporation Example

AB S Corp

A B$50

$50

50 Shares

50 Shares

AB S Corp spends $100 on deductible expenses

Losses allocated 50/50

16

AB S Corp needs an additional $100 for Year 2 operations A does not have any money B funds all $100 AB S Corp issues 100 shares to B for the extra $100 investment Sharing Ratio is now 50 shares to A and 150 shares to B Year 2 losses allocated $25 to A and $75 to B even though losses were all

funded by B

AB S Corp

A B$100$0

100 Shares

S Corporation Example - (continued)

17

Basis Increase for S Corporation

S Corporation

Shareholder

Customer Expenses IRS

IRS$40

$40

$0$100$200

5

321

4

Revenue 200Expenses -100Net Income 100Less: Corporate Tax -0After-Tax (Corporate) 100Less: 40% Shareholder Tax -40Retained Earnings 60

S Corporation distributes $40 to Shareholder for Taxes; retains $60.

Shareholder's Tax Basis Increases for the $60 of Retaining Earnings

18

Exceptions Small business service companies with one owner and no

possibility whatsoever of capital gain transactions C Corp to S Corp conversions

• Basis Increase for Earnings• Avoid Trapped Losses• In-Kind Distribution Rule Usually Prevents an LLC Conversion

Over 100 equity owners and cannot qualify as a Publicly Traded Partnership

Business is certain it will exit in a stock-for-stock merger or will be purchased in a 338(h)(10) deal

Blockers

Friends don’t let friends form an S Corp or a C Corp for a privately-owned business.

19

Initial Public Offerings

ABC Corp

A B C

ABC LLCmerge

r

A B C

ABC Corp

Public

$

Unless the business can qualify as a publicly traded partnership, ABC LLC will need to convert to a corporation before it consummates an initial public offering.

20

Blocker Corporations

• Inbound foreign investment domestic corporate blocker

• Tax exempt entity domestic corporate blocker

• REIT subsidiary domestic corporate blocker

Blocker corporations allow investors to indirectly receive income from domestic partnerships without being a direct partner.

21

Blockers: Inbound Foreign Investment Blocker

Domestic Corp

(Blocker)

A B C

B C

U.S. Partnership

Foreign Investors

The blocker corporation pays tax on its share of the partnership's income. Foreign investors avoid US trade or business income tax and instead are only subject to tax in their home country on any dividends received. Foreign investors will not be required to file a U.S. income tax return.

Domestic Investors

U.S. Real Estate Assets

22

Domestic corp. will hold all investments that generate UBTI income. Income will be taxed as corporate rates at the subsidiary level and passed tax free to the tax exempt entity.

Blockers: Tax Exempt UBTI Subsidiary

Tax Exempt Entity

Domestic Corp.

(Taxable Subsidiary)

UBTIIncome

Tax FreeDividends

U.S. Partnership

B C

Other Investors

23

Blockers: REIT Taxable Subsidiary Blocker

REIT

Subsidiary structure allows REIT to indirectly receive income that would otherwise disqualify the entity’s REIT status. Equity value of subsidiaries may not collectively represent more than 25% of REIT assets.

Domestic Corp.

(Taxable REIT Subsidiary)

Real Estate Assets

Management, Development, and Sales Contracts relating to Real

Estate Assets (Concierge services, minor dealer gain)

“Good” REIT Income

“Bad” REIT Income

Dividends

24

Certificate Type State Tax & Filing Fee

Certified Copy (each)

Same Day Fee 24-Hour Fee

Limited Partnerships - Domestic & ForeignLimited Partnership - Certificate $200.00 $50.00 $100.00 $50.00Amendment $200.00 $50.00 $200.00 $100.00Cancellation (plus taxes to cancel) $200.00 $50.00 $200.00 $100.00

Limited Liability CompaniesCertificate of Formation - domestic $90.00 $50.00 $100.00 $50.00

Cancellation (plus annual taxes to cancel) domestic & foreign $200.00 $50.00 $200.00 $100.00

Certificate Type Fee Same Day Fee

24-Hour Fee

Good Standings - ShortLimited Partnership $50.00 (per certificate) $50.00 $40.00Limited Liability Company $50.00 (per certificate) $50.00 $40.00

Certified CopiesLimited Partnership $50.00 (per document)

plus $2 per page for copies

$60.00 $50.00

Limited Liability Company $50.00 (per document) plus $2 per page for copies

$60.00 $50.00

FeeNames ReservationsLimited Partnership (120 days) $75.00Limited Liability Company (120 days) $75.00Limited Liability Partnership (120 days) $75.00Corporate Name Reservation (120 days) $75.00

$500 per document/request.

Priority 1 (1-Hour) Service is available at a cost of $1000 per document/request and Priority 2 (2-Hour) Service is available at a cost of

Delaware Filing Fees - As of December 31, 2014

25

Texas Filing Fees - As of December 31, 2014

FeesDomestic For-Profit Corporations

Certificate of Formation $300Expedited Processing Fee per document $150

Foreign For-Profit Corporations, Foreign Professional Corporations, Foreign Professional Associations, Foreign REITS, and Foreign Business Trusts

Application for Registration to do Business $750

Limited Partnerships (domestic & foreign)

Reservation/Renewal of Entity Name $40Certificate of Formation $750Certificate of Amendment $150Application of Registration to do Business $750Expedited Processing Fee per document $25

Limited Liability Companies

Fees same as domestic and foreign for-profit corporation filing fees