Tax effects flow from the date transactions occur. For example, in a recent Tax Court case, a dispute arose in regard to a change in ownership of interests in a limited liability company (LLC). For LLC's taxable as a partnership, the members are of the LLC are taxable directly on their percentage share of the income and losses of the LLC. Therefore, a transfer of an interest will result in changes to the shares of income (or loss) to be allocated to the involved members, effective as of the date of transfer.
Oftentimes, the documentation for such a transfer does not get completed until after the date the transfer occurred. Therefore, the documentation will often indicate a date the documents are signed, and a retroactive "effective date" for the transfer. In the case mentioned above, the taxpayers had such a retroactive effective date. However, they did not report their ownership as being changed as of the retroactive effective date in filing their tax returns. The IRS sought to apply the retroactive date – and the taxpayers argued that such a retroactive date would be an unenforceable backdating of a document and should be ignored. In the end, the IRS position was upheld. It is interesting that this is the opposite of what you would expect – normally it is the taxpayer that wants to use the prior effective date and the IRS seeking to ignore it.
The case was instructive of several principles that apply to retroactive effective dates. These include:
-impermissible "backdating" generally involves an effort to make it appear that the document in question was executed on a date prior to its actual execution date; i.e., there is an effort to mislead the reader. Therefore, if one is seeking a retroactive effective date for tax purposes, the first requirement is that the document be above board as to what is going on. Thus, showing the true date the agreement is signed, along with an earlier "effective as of" clause, is advisable. What is not advisable is to date an agreement as being signed on a date that is earlier than the date of actual signing.
-To be effective, a retroactive effective date must be allowable under applicable state law. In the case, the Tax Court noted that this was the case in Georgia, the state involved.
-The purpose of the retroactive dating cannot be to obtain an unwarranted tax benefit. In the case at issue, the IRS didn't really care which members picked up the income – changing the percentage ownership among them did not avoid tax it just shifted it among the members. While one could see a situation where the IRS would care (based on relative tax rates, or available losses) which member picked up the income, the fact that the parties are acting at arms-length also goes a long way to protect against a "tax benefit" objection by the IRS.
-The Tax Court will be more willing to accept a retroactive effective date if it can be shown that the later written documents is merely a memorialization of a prior oral agreement. Therefore, if this is the case, it would probably be helpful to recite this in the documentation.
Barry E. Moore, et ux., TC Memo 2007-134