Category: Capital Accounts

TAX JOURNAL ARTICLE ABOUT MAINTAINING CAPITAL ACCOUNTS

By , December 29, 2015 12:44 pm

Even LLC lawyers who never handle tax matters should have at least a basic understanding of partnership taxation, since this is the federal tax regimen that governs most multi-member LLCs.  In particular, they should have a basic understanding of how to maintain the capital accounts of members of multi-member LLCs taxable as partnerships.  A friend just sent me a copy of an article about this subject in a 2014 issue of a tax journal called Taxes.  I’m looking forward to reading the article.  Here are the title and author of the article and a brief description of it (I can’t send you the article itself because it’s copyrighted):

February 2014
TAXES—THE TAX MAGAZINE®
©2014 J.R. Hamill
James R. HamillCPA, Ph.D., is the Director of Tax Practice at Reynolds, Hix & Co., P.A. in Albuquerque, New Mexico.

Partnership Code Sec. 704(b) Capital Account Maintenance—Permitted Adjustments Can Track Partners’ Economic Arrangements
By James R. Hamill
James R. Hamill discusses the benefits of a partnership maintaining Code Sec. 704(b) book capital accounts, either in isolation or in addition to one of the other available methods and how those
capital accounts should be maintained.

NEW ARTICLE ON CAPITAL ACCOUNTS

By , July 3, 2015 8:14 am

The capital account provisions in the operating agreements of LLCs taxable as partnerships are critical both in defining the economic deal among the members and in defending this deal if challenged by the IRS upon audit.  Donald J. Weidner, Dean and Alumni Centennial Professor, Florida State University College of Law, has just published an article in Florida State U. Business. Rev. 1 (Spring 2014), entitled CAPITAL ACCOUNTS IN LLCs AND IN PARTNERSHIPS: POWERFUL DEFAULT RULES AND POTENTIAL TAX SIGNIFICANCE.  It’s an excellent article; I recommend it for anyone who wants to expand their understanding of capital accounts.  Part VI of the article, entitled “Conclusion,” provides a succinct summary of the article’s content.  Here is that conclusion.

VI.  Conclusion

In the financial crisis that started to unfold in 2007, it became widely known that investment bankers, and their lawyers and accountants, had drafted documents for financial instruments so complex as to be beyond comprehension. However impenetrable, language and structures migrated and became widely accepted once they passed muster. Former Federal Reserve Chairman Allan Greenspan quipped that, even with more than 100 economists at his disposal, he could not *29 untangle the agreements or structures behind billions of dollars of collateralized debt obligations. Unfortunately, something similar, although perhaps not quite as extreme, has happened within the more modest arena of LLCs and partnerships. Despite the fact that these are two premier vehicles for small businesses with two or more owners, they are often governed by agreements that are very difficult to understand. Operating and partnership agreements are often drafted by generalists who incorporate standard form language that attempts to validate special allocations of tax benefits that might be made, even if implausible. Although the relevant federal income tax regulations focus heavily on capital accounts, those capital accounts are often misunderstood and can have significant and unintended economic consequences.

My thesis is twofold. First, even apart from federal income tax law, attorneys must have at least a rudimentary understanding of what capital accounts are and are not, as well as any state default rules regulating them. The accounting profession typically is generating individual capital accounts for each owner, even if those accounts are not required either by the owners’ agreement or by law. In the world of small business, often characterized by incomplete or vague agreements and by poor record-keeping, those accounts provide at least some standardized measure of an owner’s net equity in the firm. Second, capital account analysis is a useful analytical device. Walking the standard range of anticipated transactions through a capital accounts analysis can raise with great clarity and precision basic economic decisions that might otherwise be overlooked, particularly decisions regarding the sharing of different kinds of losses among the owners.

TARGET CAPITAL ACCOUNTS

By , November 1, 2013 9:22 am

Most well-drafted LLC operating agreements provide for allocations of LLC profits and losses to the members and distributions to them of LLC cash and other assets on the basis of “layer-cake” provisions—i.e. a “layer” consisting of specific provisions making these allocations and a separate layer consisting of provisions for interim and liquidating distributions based on these allocations.

However, among sophisticated practitioners, a new approach has emerged in recent years, called the “target capital account” approach.  LLC practitioners should be aware of this new approach, since, at least in LLC deals involving complex financial arrangements, a target capital account approach may be indispensable for their clients.  For an excellent introduction to the use of target capital account provisions, click here.