Discussion:SMLLC and Unit (Stock) Options
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Discussion Forum Index --> Advanced Tax Questions --> SMLLC and Unit (Stock) Options
Discussion Forum Index --> Tax Questions --> SMLLC and Unit (Stock) Options
| 21 July 2008 | |
| Got a bit of a mess handed tome. I have a few questions to work through. I have been reading what guidance I can on the net. I have a client who was supposed to be organized as a SMLLC...the only issue is that the Articles or Organization listed two other "members" that had a profit-only interest and contributed no capital. This was later changed to an option of interest rather than direct interest. Based on my review the optionees do not have an interest in the liguidation of assets, just profit going forward. My understanding is that they would not have a capital account in this instance. Should this be taxed as a partnership or a Schedule C?
Additionally compicating the matter is the fact that the FEIN was assigned to a partnership and they filed an extension for a 1065. So is a SMLLC that issues interest only unit option a partnership? Is know the other option is to elect to be taxed as a corporation and then check the box as an S-Corp...but is this levelof complexity necessary? Thanks in advance. | |
| July 21, 2008 | |
| You have to determine whether, under general federal tax principles, the options make their holders partners already. Certainly, if the holders have a definite right to a portion of all profits from today, they're partners today. | |
| 23 July 2008 | |
| Sorry about the delayed response. The options do not really specify if they have rights to assets upon dissolution so it is unclear if the options would represent a capital interest or a profit-only interest. The interest is only in appreciation going forward once exercised. No options have been exercised to date. Did issuing the options make the SMLLC a partnership or is a partnership formed the day one of the options is exercised?
The intention was to share profit and limit the liability of the optionees...should they be treated as LP and the member be the GP? | |
| July 23, 2008 | |
| In principle, having an option to become a partner is just that; if there's one owner today, and other people just have the possibility of acquiring interests in the future, then it's a DRE today and would become a partnership upon exercise. The problem is that the options could be treated instead as interests in the partnership if that is their economic reality. Is the exercise price zero or a trivial amount? Upon exercise, will the optionholders acquire partnership interests with zero capital interest at that time (i.e., if there are earnings between now and then, will those earnings benefit the optionholders)? Is there substantial doubt about whether the options will eventually be exercised? | |
| July 23, 2008 | |
| I agree with LH...very clear logic. Subject to whatever a DRE is. Definite? Right? to Excercise? Equity? nah, Exercise I bet... | |
| 23 July 2008 | |
| there was this concept of 'ghost stock' or 'phantom stock options' or something about 10-15 years ago, the idea being that actual stock wasn't issued, the holder only shared in 'appreciation' (but without actual ownership) like one would share in profit sharing (which may or may not include ownership). May want to google it. | |
| July 23, 2008 | |
| DisRegarded Entity. You know, a single-member entity whose regard has been dissed by the IRS. | |
| 24 July 2008 | |
| Thanks for the info LH (and others). The options have a time vesting element. The exercise price is trivial ($0.001) so the new partners will have a nominal basis. Still think DRE until exercised? | |
| 24 July 2008 | |
| Kevin, phantom stock is still very much alive and kicking. I'm setting one up now for a client who wants to tie in key employee for a long time without giving up actual stock ownership. Recent Sec 409A Regs gives the guidelines. | |
| 25 July 2008 | |
| OK...I think I am getting a clearer picture but I would like any vets out there to validate my reading comprehension skills. There were four options that are for restricted capital interest. One was given this year and the others were given a few years ago. The ones given a few years ago are either partially or fully vested. My understanding is once one of the options vested a partnership was born (SMLLC prior) and the optionee should have recognized income equal to the value of that capital interest the day is vested, right (no one made 83b election)?
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| 25 July 2008 | |
| I think I'm getting it, finally. Although the options are vested, they haven't been exercised. I'm inclined to go along with the partnership idea. The value of the vested options, since they are unpaid are a liability of the partnership, with an M-1 adjustment for that value. Since there is no income element to those options, the general partner would have 100% of the income on his K-1. The owners of the options would get K-1s showing zero income. Does that work? | |
RoyDaleOne (talk|edits) said: | 25 July 2008 |
| My comment is that I would think the IRS position would be that the individuals became partners at the time the "options" were granted.
Because: This "Is there substantial doubt about whether the options will eventually be exercised?" coupled, with this: "The exercise price is trivial ($0.001) so the new partners will have a nominal basis", results in only a fool would not pay the mill. Substance over form, or a sham purchase price. Heck I would pay a 100 times that amount or $.01 as the exercise price. You can have a current member who only would shares in a percentage of the future appreciation, and none of the losses, and does not have a contributed partner's capital account (only one resulting only from a share of the profits). Are these people related? Why, such a good deal? Is this a part of a financing package? <----- I have seen this type of deal in a financing arrangement. Disagree, please. | |
| 25 July 2008 | |
| The only doubt would be the risk of assuming current and future debt since it is a start-up. That is the only real doubt. One option holder is an employee ofthe LLC...the others are an advisory board of "directors". | |
| 25 July 2008 | |
| Oh and they are not related. The deal waas just due to being a start-up and using aton ofthe cash on equipment. Would they be limited partners (except for the employee w/ option)? | |
| 25 July 2008 | |
| I don't think I've ever encountered anything like this before, has anyone looked at the state law on any of this? | |
RoyDaleOne (talk|edits) said: | 25 July 2008 |
| This is an llc not a partnership, therefore, unless the options committed the option holder to "sign on" on any debt the member would not automatically be assuming responsible for any debt.
I know in Florida this type of agreement is legal. As Crow says the state law should be vertified for legality. I would think that the option members would be treated as limited partners. | |
