Last night we held our first coaching call with our School of Tax Strategy participants. Thanks to everyone who joined in. There were many excellent questions and terrific discussion regarding Entity Fundamentals, this month's topic.
Gerald from Phoenix followed up with a question that I want to address:
Q: Thank You for answering all the questions this evening, I have learned plenty. I have one question that came at the end of the session. can I have my limited family partnership be a member of an LLC? I just did seven of these and I'm planning to fund them early next week. advise me if I'm making a mistake.
A: Yes, your family limited partnership, or FLP, can be a member of your LLC, so long as you have not elected to tax the LLC as an S corporation. There are no real restrictions in the Internal Revenue Code for who can be a member of a partnership (remember that we discussed that an LLC with multiple members is automatically a partnership for tax purposes if we don't elect to tax it as a corporation). Similarly, there are no real restrictions on ownership of a single-member LLC (as we discussed - treated as a disregarded, or invisible, entity by the IRS) or of a regular, C corporation. Only S corporations have restrictions on ownership.
Let me also follow up a bit on the concept of "nexus." As we discussed, nexus the amount of connection you must have with a state in order for the state to have the right to tax you. If your entity was formed in a state or has commercial domicile in the state, the state automatically has jurisdiction and can require you to file an income tax return. However, as I mentioned, there have been several states over the past few years that have taken the position that if you direct meaningful economic activity (e.g., advertising) into the state, then you have sufficient connection or nexus with the state to allow them to impose an income tax.
The controversy stems from a Supreme Court case by the name of Quill v. North Dakota. In Quill, the Court ruled that at least for sales tax purposes, a company must have some physical presence in order to have nexus and be subject to the taxing jurisdiction of the state. The Court specifically mentioned that it was not deciding the question of nexus for other tax purposes (read income tax). Some state Supreme Courts have interpreted this to mean that income tax does not require physical presence. Personally, I believe this is patently incorrect and not only goes contrary to Quill, but also goes contrary to Quill's predecessor, National Bellas Hess, which was not overuled by Quill, but rather confirmed by Quill.
In the meantime, be aware that states are becoming rather aggressive. If you are doing business in multiple states, I STRONGLY recommend that you work with a multi-state tax expert to help you decide in which states you need to file.
Remember that next month we will be talking about "Building Your Perfect Foundation." In this topic, we talk more about entities and how you can use them specifically in your Tax Strategy. Don't forget to do your homework and keep those questions coming.
Warmest regards,
Tom