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Sunday, November 04, 2007

IRS INTEREST CONTINUES IN SUCCESSIVE MEMBER INTEREST CONTRIBUTIONS

In August 2007, the IRS issued a Notice [Notice 2007-72] that it was designating a form of charitable contribution as an item "of interest." As such, persons entering into those types of transactions, and their advisors making tax statements with respect to them, are subject to disclosure and list maintenance requirements.

The IRS is now beginning to examine exempt organizations and government entities suspected of participating in successive member interest contribution arrangements. As part of the examination, the organizations receive an extensive questionnaire, which the IRS indicates it is using to determine if these types of transactions should be treated as a tax avoidance type of transaction, and whether the transaction should be designated as a listed transaction.

So what is a successive member interest contribution? According to the IRS:

In a typical transaction, Advisor owns all of the membership interests in a limited liability company (LLC) that directly or indirectly owns real property... that may be subject to a long-term lease. Advisor and Taxpayer enter into an agreement under the terms of which Advisor continues to own the membership interests in LLC for a term of years (the Initial Member Interest), and Taxpayer purchases the successor member interest in LLC (the Successor Member Interest), which entitles Taxpayer to own all of the membership interests in LLC upon the expiration of the term of years. In some variations of this transaction, Taxpayer may hold the Successor Member Interest through another entity, such as a single member limited liability company...After holding the Successor Member Interest for more than one year (in order to treat the interest as long-term capital gain property), Taxpayer transfers the Successor Member Interest to an organization described in § 170(c) (Charity). Taxpayer claims the value of the Successor Member Interest to be an amount that is significantly higher than Taxpayer's purchase price [and]...claims a charitable contribution deduction...based on this higher amount.

The IRS is concerned with the large discrepancy between (1) the amount Taxpayer paid for the Successor Member Interest, and (2) the amount claimed by Taxpayer as a charitable contribution.  It also has the following concerns which may be present in some variations of this transaction: (1) any mischaracterization of the ownership interests in LLC; (2) a Charity's agreement not to transfer the Successor Member Interest for a period of time (which may coincide with the expiration of the applicable period in § 6050L(a)(1)) [relating to the obligation of a charity to report the details of a sale of contributed property that it received within 3 years of the sale]; and (3) any sale by Charity of the Successor Member Interest to a party selected by or related to Advisor or Taxpayer.

It goes without saying that any exempt organization that is approached to participate in one of these contribution arrangements should probably decline, at least until more guidance is issued by the IRS as to when, if , and under what circumstances, such transactions will be respected as legitimate.

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