In episode 55 of How Tax Works, Matt Foreman discusses S Corps (again), the viability of the GP/LP structure, the Fifth Circuit’s decision in Sirius Solutions, and the future of section 1402(a)(13) of the Internal Revenue Code.

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How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

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Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matthew Foreman [00:00:00]:
Hello and welcome to the 55th episode of How Tax Works. I’m Matt Foreman. In this episode, I will discuss entity selection part 2 payroll taxes in the Era of Soroban Capital Partners and Serious Solutions How Tax Works is meant for informational and any entertainment purposes only. This may be attorney advertising and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business business decisions that we all make. Before we get started.

Matthew Foreman [00:00:45]:
Few administrative things New episodes every two weeks. Next episode will discuss the imposition of interest after quang and generalized government sloppiness. If you have any questions, comments or constructive criticism, you can email me at my FRB email address. You can find View your favorite search engine though no longer Ask Jeeves. Apparently that’s closed now. Upcoming Webinars and Speaking Engagements honestly go to LinkedIn connect with me on LinkedIn. I talk about. I post everything I do.

Matthew Foreman [00:01:11]:
So if you just kind of do that, you’ll see them. I have some real good ones coming up for the fall CLE CPE cell for a lot of different ones. Even even has continuing ED for CFPs. So that’s a, that’s a good one to get on some some technical tax topics, doing some with partners. So that’ll be good. So any selection? Part 2 Payroll taxes in the Era of Sorbonne Capital Partners and Serious Solutions so before I actually really get into the the Nitty Gritty, this is the first episode of the third year. You may notice this is episode 55. Combination of kind of how the Mondays Fall and the fact that I did two episodes at once for the AI just kind of released them both at once, even though it was a little extra extra work because I didn’t space them out but thought it made more sense.

Matthew Foreman [00:01:55]:
So we are, we are in year three, not doing seasons, sort of like ufc, but I just keep the numbers increasing. So you know, this is, this is HTW55 as as the kids are calling it. Maybe we’ll get get a nice claw in there. This is also the first episode since the New York Knicks won the NBA championship. New York is still rioting. I don’t know if you can hear it outside, but it’s just, it’s just crazy. It was. It’s a lot of fun.

Matthew Foreman [00:02:23]:
As anyone who lives in New York or has lived in New York for a period of time knows New York is a very split team city. You know, Mets and Yankees are 60, 40, maybe closer, maybe not. Giants, jets again, 60, 40, maybe 50, 50. I don’t know. I don’t, I don’t know. Look into this. And then the Rangers kind of have a weird split with the Islanders and I guess the Devils. I really don’t understand how that one works.

Matthew Foreman [00:02:46]:
But the Knicks, the Knicks are New York’s team and people are saying, oh, what about the Nets are in Brooklyn. No one, no one, no one pays attention to the Nets. I’m sorry if that’s mean or mean spirited or I’ll get in trouble for it, but it’s, it’s, it’s basically true. So really, really was a fun time in the city and just, you know, cool to see it, you know, and being on the subway and people talking about the Knicks with people, people you’ve never met before. So that was, that’s, that’s always a lot of fun. Anyway, so this, this episode is a combination of a continuation of the first episode of How Tax Works which discussed any selection and the 11th and 12th episodes which discussed the imposition of payroll taxes under section 1402 a13 of the Code and analyze the Second Circuit and tax court decisions in Soroban Capital Partners. I think it’s really, really, really important to note that I’m assuming, I mean any selection the first episode, you probably know that, but that you’ve listened to the 11th and 12th because I’m going to talk about Sorbonne Capital Partners and a somewhat companion case series Solutions, but I’m going to assume you’ve listened to it and I think that’s important. Anyway, so in January, which I know was a couple months ago, the fifth Circuit ruled in Serious Solutions, which is the opposite way of Sorbonne Capital Partners.

Matthew Foreman [00:04:04]:
But it’s interesting and there’s tax planning for both and you can tax plan both at the same time. Also a circuit split which we, we now have could mean that the Supreme Court will take may take it up and no one knows what they’ll do because Supreme Court just kind of does weird stuff especially boy howdy, especially with tax. Right. So I think that’s an interesting kind of dynamic that, that we’re playing with here. See what happens. So let’s start by talking about entity selection s corps. Why do people love them? You save on payroll taxes, it creates a regarded entity for single owner purposes even though it generally doesn’t pay tax. And because let’s be honest, you want to antagonize me as someone who actively dislikes s corporations.

Matthew Foreman [00:04:45]:
I think that’s actually a valuable thing. It’s, it’s probably funny for the most part to do. And, and I understand it, I really do. But, you know, the important thing is sort of to understand the mechanism through which S corporations save on payroll taxes, right? So there’s, if you’ve an S corporation and you’re active in the trade or business, you’re required to pay yourself reasonable compensation. What is reasonable compensation? No one really knows. It is a reasonable amount based on your experience, what you do, the market, etc. Etc. The rest of it, the rest of the profit of the business is distributed without payroll taxes.

Matthew Foreman [00:05:19]:
So that’s why people do it, to save on payroll taxes. Ta da. Right. So what, what about LLCs? What about limited partnerships? What about limited liability limited partnerships and that. That’s what this is all about. Things that are taxed as partnerships, but they may or may not be actual partnerships. Right. So let’s go back to 1402, section 1402 a.

Matthew Foreman [00:05:41]:
13. When it was enacted, it was 1402, 8, 12. It has since become 13. And the intent of it is actually really interesting. The intent was to exclude passive investors from payroll taxes. So they, they did not, did not get the benefit of Social Security on that income. The goal was to say, look, as a passive investor, you’re more of an investment in nature, therefore you don’t get the benefit of Social Security. The intention is kind of flipped, right? You know, not now.

Matthew Foreman [00:06:12]:
It’s. People are trying to avoid payroll taxes because they’re not a great roi. They never really were. But I guess people didn’t realize that. I don’t, I don’t know. It was a, was before I became a tax lawyer. So I really, I don’t, you know, I conceptually understand what the reasons were and why they did it. But it’s just a different world from what we have right now.

Matthew Foreman [00:06:31]:
The language is no payroll taxes on, quote, the distributive share of any item of income or loss of a limited partner comma, as such. The Tax court said, right. A limited partner comma, as such means income and loss in their capacity or role as a limited partner. The Tax Court in Sorbonne said to look at the function of the person and collapse the role. Second Circuit affirmed in Soroban Capital Partners. The fifth Circuit took the case after the Tax court kind of nudged it along. Said, oh, look, there’s Soroban. Tax court’s already decided.

Matthew Foreman [00:07:05]:
So the fifth Circuit is the first place you’re going to litigate this because the Tax Court said, look, there’s the exact same facts or close enough. And so we’re going to just follow it, move it along pretty quickly. The 5th Circuit and I’m burying the lead here, but you know, here we are. The Fifth Circuit rejected the tax court and second Circuit functional approach and it said a limited partner exception applied to partners in state law. Limited partners, partnerships that had limited liability. That’s it. As long as you are a limited partner under state law, you are a limited partner as state such. I am about to go really deep into serious.

Matthew Foreman [00:07:39]:
Right. But before I do, Quick break, get some music in. Before we go to the music, actually I want to point something out the, the earlier today I had to call New York State. As you know I do as a tax lawyer, you call states every so often and their music was a little poppier, little, little more, a little more jazzy funky than the music you’re about to hear. If you don’t know the source of this music, then I don’t know if I envy you or if I, I feel badly for you because you’re missing what I think is a pretty, pretty funny joke. I enjoy jokes like this, so I think it’s funny. But you know, just for those wondering, no, we’re, we’re not changing the music because we have a license for it and we’re going to keep using the license because I think it’s, I think it’s pretty good music for what we’re doing Anyway, so before we get to talk about Series Solutions, let’s take a quick musical break. Be right back.

Matthew Foreman [00:08:34]:
Foreign. So we’re back. So Series Solutions LLLP. Is that too many Ls? No, it is a limited liability limited partnership, sort of like an llp, but the partnership itself can do less. Instead of a limited liability partnership, limited liability, and the partnership itself is limited. The case is 2014, 2015 and 2016. So it’s pre BBA, no tax matter. There’s a tax matters partner, not a partnership representative.

Matthew Foreman [00:09:07]:
Thought that was actually kind of interesting. Throwing it, thrown it back. I’ve now been practicing long enough where I am used to one set of laws and then all of a sudden you see litigation involving predating. Right. So interest. Pretty heavy. So despite roughly in serious solutions, only 0.75% had a GP ownership interest. But 100% of the income was allocated to the LPs.

Matthew Foreman [00:09:30]:
So there actually was no income, none, zero. That was subject to payroll taxes. So pretty aggressive stance there. Thought that was interesting. So they started the analysis by looking at dictionaries in 1977 the time of enactment. The dictionaries focused on how a limited partner had limitations on liabilities. That was the key. The dictionary said that the general partner has unlimited liability.

Matthew Foreman [00:09:55]:
Let’s talk about serious solutions. LLLP. Is that too many Ls? No, it’s a limited liability limited partnership. In addition to limiting the liability, it also limited limits the role of the partnership itself limits what it can do and what the partners can do. This case deals with 20, 14, 15 and 16. So instead of having a tax matters part. Excuse me, instead of having a partnership representative which we now have, it’s pre bba. So you have what’s called a tax matters partner.

Matthew Foreman [00:10:21]:
Okay. Despite roughly 0.75% of the total ownership was owned by the general the general partner or GP. 100% of the income was allocated to the LP. So I always ask the question, is there actually a gp? Maybe not. Thought that was interesting. Kind of glossed over that fact, so I thought that was interesting. Anyway, so it started by looking at the dictionaries in 1977 which is the time of enactment of 1402 a 13 of the code, again as 1402812 but it’s been moved without modification. So you have that situation.

Matthew Foreman [00:10:55]:
And the dictionaries at the time focus on how limited partners had limitations on their liabilities. The dictionary says a general partner has unlimited liability. Of note, the GPS and Sorobot and Sirius were both LLCs. So the GP has unlimited liability but no actual individual has limited has any liability exceeding of course their investments, what they actually invested. People. Someone commented, well look like this is a 1977 law. We’re dealing with LLCs. Is that really relevant? I thought that was a really good point that someone sort of commented on to me once.

Matthew Foreman [00:11:27]:
We were talking about another tax practitioner talking about sort of what we’re seeing here. And I thought that was interesting. You know I always say this situation where the law is no longer or may not be relevant to what’s to the facts. So that’s interesting. But anyway, this was sort of your standard, what I call GPLP structure or LPGP structure, whatever you want to call it to know. You know, again pre LLC is the general partner was just an S corporation. That’s all it was. So it really didn’t do it.

Matthew Foreman [00:11:54]:
I’m of the opinion that the reason that LLC are taxed as partnerships, the reason why the IRS says they are in their sub regulatory guidance is because you can just do a GPLP structure and have an S Corp so you can functionally Create the LLC without it. So they’re like, all right, just go ahead, do it. It’s fine. As noted in footnote five, that the limited partners are limited in the amount of business they can conduct. This is a much larger point in Sorobond, but it’s a footnote here. It’s important to note that the GPs, the owners of the GP entity, were active in the business. And that’s really important to note. And it’s really, really, really important to note for one extremely specific reason.

Matthew Foreman [00:12:35]:
Because of the fact that the GPS. There are people who are GPS and LPs, and they’re both. This question is not a question of what happens to someone who’s only an lp. That person’s fine. It’s someone who is a GP and an lp. That’s the key. All right, how do you separate. What the IRS is doing is changing, and this is what the court said the IRS is doing is changing the definition of a limited partner to what is perhaps a current definition.

Matthew Foreman [00:13:02]:
But the IRS is bound by the definition at the time of the enactment of the statute. Okay, so originalist, right. IRS Tax Court, 2nd Circuit and dissent say a limited partner is a mere passive investor. But maybe that’s not really relevant. As such. Right. Limited partner, comma, as such. The.

Matthew Foreman [00:13:19]:
As such implies to a function. The IRS never raised this in this litigation. I had someone say that the IRS wanted to lose one and they figured they’re going to lose in the Fifth Circuit anyway. They love, love, love the originalist views down there. So they just didn’t ra. They figured this way. Look, we’ll get a circuit split, get the decision. I’d go the other way.

Matthew Foreman [00:13:38]:
I’d try to win every single time. And if you win every single time, then there is no circuit split. But I sort of wanted to point out, and I think it’s really important to note that in not arguing it, it sets up an argument for the unbonc to do so. I thought that was interesting, you know, and that’s, and that’s really important. So again, irs, Tax Court, Second Circuit, all rely on legislative history, which the, the majority here, the. The decision, majority decision set here. And they, they, you know, it’s interesting, the. About half of the majority actually is just a response to the dissent.

Matthew Foreman [00:14:13]:
I’ve always found that to be a sore winner kind of way to do it. You don’t really need to respond to the dissent when you’ve won. There’s an old adage among law professors, which is if the judge is taking your position Stop talking. And I thought it was curious, interesting. I don’t know that the judge won and spent the whole time talking about the other side. Kind of curious here, but anyway. But the dissent, which I’m not going to go into, you know, is really just, just the opinion Sorbonne. They parroted it.

Matthew Foreman [00:14:48]:
You know, they knew what the argument was. They didn’t really go through it. They went through in detail. But I’m not going to go through here. If you want to know what the majority says in Sorbonne, listen to the prior ones. It’s really just the IRS position. Few comments I think are important on this. There were no allocations to the general partner at all.

Matthew Foreman [00:15:04]:
The LLP doesn’t really have a general partner because if it is a general partner, if you’re not an economic partner, right. So you only have limited partners. So this is not an lpgp, this is just an lp. I don’t think that can exist. I don’t think that’s a partnership between them. So I thought that was curious that this was the one they went to. I think this is why this is one the IRS did not settle. I am aware of a number that the IRS has settled that have this basic issue.

Matthew Foreman [00:15:30]:
They definitely picked the ones that they felt were the, were fact patterns they didn’t like. And I think the litigants really all did it. Also I should note that Sirius and soroban and point 72 and there’s one more that I’m spacing on at the moment because I didn’t write it down. They all have the same litigators. It’s the same litigators from Scadden who are annoyed at me for not saying Scadden Arps. But they, you know, I thought that was interesting that they’re, they’re litigating them all no matter what circuit. I mean is a national firm. But nonetheless, usually when you have stuff like this, you have one firm, two firms doing.

Matthew Foreman [00:16:00]:
It’s really just the one. Although there’s a lot of firms kind of signed on to this also there’s no discussion at all regarding the actions or identities of the limited partners. You know, can they even possibly exceed the activities permitted by state law and lose limited parties party status? That’s actually something discussed in Sorbonne, not discussed here. They really did a quick and dirty we’re done. So basically the rule what came out of this case is if an L, if you are an lp, there’s no payroll taxes on your allocations of income as a limited, you know, from being a limited partner. That’s it? I don’t know. I was kind of annoyed by it. I mean, for one, I.

Matthew Foreman [00:16:35]:
I really see the functional test. I actually see it. I think that’s what the comma and such means. But, you know, fundamentally, I think that’s really where it went wrong, is they just kind of didn’t discuss it. And I find it sort of fascinating that they spent a whole lot of time just talking about the dissent, but they never actually discussed what the people do. They never really discussed the counter argument to it, the functional argument, whether it is even possible, why it’s wrong, why it was applied wrong. They just said, no, we don’t like that. Have a nice day.

Matthew Foreman [00:17:02]:
Look at these dictionaries, right? I don’t know. I don’t know. I. It always bothers me because the majority in Soroban, for example, discussed the other side. And I’m always irked by majority decisions that don’t discuss the dissent arguments and in any way, shape or form. I know I said, you know that, but kind of kept parading out the majority’s arguments and just saying, no, no, they’re wrong. Have a nice day. It’s not what we meant.

Matthew Foreman [00:17:27]:
But it doesn’t actually apply to the facts. Doesn’t say. Which is suggestive to me that if the. The court in Sorbonne Capital Partners, again, Tax Court, second Circuit, is to prevail, that this would have to go back to the Tax Court for factual findings, which is kind of annoying, but I. I guess that’s life. It’s also possible. It’s not really in the record. They just kind of stipulated to certain facts because there wasn’t a trial at the Tax Court.

Matthew Foreman [00:17:54]:
Didn’t need to be. So I thought that was interesting. Anyway, so let’s get some more music in. Get it in, and then we’ll bring it on home with. With some of my thoughts. So. So I’m back. And talk about any selection, part two.

Matthew Foreman [00:18:28]:
Where does that leave us? The fifth Circuit, if you’re a limited partner, no payroll taxes. Better than an S Corp, isn’t it? Huh? You know, Tax Court, second Circuit. Look at the function of limited partners. They may have payroll taxes. All right, Tax Court is everywhere but the fifth Circuit, effectively. Right? I know there’s a first Circuit case and the other one’s in Connecticut, so it’s second Circuit, so they’re not going to hear it. It doesn’t matter. Although it on bonk.

Matthew Foreman [00:18:52]:
They might end up just having them discuss it. But again, same attorneys, so whatever, everywhere. Look, if you’re only a limited Partner. And you only do limited partner things, no payroll taxes. So if you’re not at all involved and someone asked this question, you know, a while ago to me, a client, and I said, no, no, no, you have. You have nothing to worry about. Because if you are only a limited partner and you’re not at all a general partner, you’re not involved in the active business, nothing at all, then you have nothing to worry about. Right? So what about LLCs? This is like the really interesting question that I get.

Matthew Foreman [00:19:23]:
What about LLCs, right? Question is whether an LLC member, right? So technically, member is a limited partner. If you look at the Fifth Circuit, right. Well, it has limited liability and it’s a tax partnership. I make the argument, and I think there’s a lot of viability to it, that that person should get it on their total share. They’re not a general partner. Maybe you should have a separate ownership interest that delineates the two. Because if you’re really making it one interest, that’s gpnlp. That’s kind of interesting.

Matthew Foreman [00:19:55]:
Might struggle a bit. But the 2nd Circuit also says that if you function as a limited partner, right. Effectively defined as a passive investor, so an LLC, again, you know, should qualify there too. So the GPLP lives, but along with the LLC, right? So in theory, 100% of the income could be excluded from income if the 5th Circuit. If you’re in the 5th Circuit, and 100% if you function as a limited partner. Right. So I thought that was really interesting. You know, I really.

Matthew Foreman [00:20:24]:
This is one of those ones where I really. I think you can kind of plan into this, right? Have an llc, allocate a lot, have your function, you know, do I think Sorbonne’s capital partners. Right. You know, I don’t know any other way to define a limited partner as such other than the way the 2nd Circuit does it. But the 5th Circuit’s argument isn’t entirely out the lunch. They’re saying, look, they intended to be a limited partner. That’s it. I always think that this is my, you know, my editorializing here.

Matthew Foreman [00:20:56]:
But I think where the. The Second Circuit does it, right. Is the. As such is kind of superfluous. Superfluous. Superfluous. The Second Circuit’s kind of. The as such is kind of superfluous because if you do it under the Fifth Circuit analysis, because then it would read the law.

Matthew Foreman [00:21:12]:
Would have to read, as. You know, I’m gonna get this. This. This line, right? Okay. It will say, you know, no payroll taxes, is, quote, distributed share of any. Of any income or loss of a limited partner, period. Right. So I think that that’s where the problem comes in.

Matthew Foreman [00:21:30]:
I didn’t. I just don’t. I think they give short, short shift to it. So I think the Tax Court, 2nd Circuit are correct. But the 5th Circuit cited Lopea Bright and it also cited a book review of Chief Justice Roberts book, which is a bit brown nosy for, for me, but Such is life, you know, Denim Count and Partners. That’s the, that’s the First Circuit case. I did have it written down, just not before. That’s going to get a hearing soon.

Matthew Foreman [00:21:52]:
And I think I’m really curious how that one goes. First Circuit’s an interesting, you know, circuit. They all have their own quirks, but First Circuit is definitely interesting. I think both Sorbonne and Cirrus will be reheard at en banc, which for those who don’t know what that is, occurs to me that maybe people don’t. En banc means that the entire circuit will hear the case. So not just a three judge panel. It will be, you know, the 20 or so judges or something like that. So it’s functionally a rehearing.

Matthew Foreman [00:22:19]:
You already know where three of the judges stand. Although theoretically they could change their position positions and that can be interesting. So I think we could have a rehearing and then that would set up for Supreme Court hearing, you know, if cert’s granted in 2028. Right. Because in 26 we’re having bonk in a first circuit. You’re going to grant cert in 2027 and then the hearing will be in 2028 and then in 6042 we’ll have a decision and that’ll be great. Right? Wonderful. So that was the 55th episode of How Tax Works.

Matthew Foreman [00:22:52]:
Hope you learned something. Hope you enjoy it. I’ll be back in two short weeks with the 56th episode. Can you believe that? And I’m going to talk about the imposition of interest and actually kind of penalties too, after quag and the generalized issues with government sloppiness in drafting and legislating and executive functioning and other issues that go along with it. Thank you for listening. Hopefully hear it. Talk to her again in two weeks. Sam.