Kwall's The Federal Income Taxation of Corporations, Partnerships, Limited Liability Companies, and Their Owners PDF
Preview Kwall's The Federal Income Taxation of Corporations, Partnerships, Limited Liability Companies, and Their Owners
FOUNDATION PRESS EDITORIAL BOARD SAUL LEVMORE DIRECTING EDITOR William B. Graham Distinguished Service Professor of Law and Former Dean of the Law School University of Chicago GUY-URIEL E. CHARLES Charles J. Ogletree Jr. Professor of Law Harvard Law School NORA FREEMAN ENGSTROM Ernest W. McFarland Professor of Law Stanford Law School DANIEL A. FARBER Sho Sato Professor of Law University of California at Berkeley HEATHER K. GERKEN Dean and the Sol & Lillian Goldman Professor of Law Yale University SAMUEL ISSACHAROFF Bonnie and Richard Reiss Professor of Constitutional Law New York University HAROLD HONGJU KOH Sterling Professor of International Law and Former Dean of the Law School Yale University THOMAS W. MERRILL Charles Evans Hughes Professor of Law Columbia University HILLARY A. SALE Agnes Williams Sesquicentennial Professor of Law Associate Dean for Strategy, and Professor of Management Georgetown University UNIVERSITY CASEBOOK SERIES® T F I HE EDERAL NCOME T AXATION OF C , ORPORATIONS P , L ARTNERSHIPS IMITED L C , IABILITY OMPANIES AND T O HEIR WNERS SEVENTH EDITION JEFFREY L. KWALL Kathleen and Bernard Beazley Professor of Law Loyola University Chicago School of Law The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. University Casebook Series is a trademark registered in the U.S. Patent and Trademark Office. © 1995, 2000, 2005 FOUNDATION PRESS © 2012 By THOMSON REUTERS/FOUNDATION PRESS © 2016, 2019 LEG, Inc. d/b/a West Academic © 2023 LEG, Inc. d/b/a West Academic 444 Cedar Street, Suite 700 St. Paul, MN 55101 1-877-888-1330 Printed in the United States of America ISBN: 978-1-63659-465-1 To my grandchildren, Sander and Kaia and to the memory of my mentor, Stuart Duhl PREFACE TO THE SEVENTH EDITION Much has occurred during the almost three decades since this casebook was originally published. The seventh edition incorporates the Inflation Reduction Act of 2022 and reflects the many Internal Revenue Code amendments, regulations, court decisions and Internal Revenue Service rulings that have modified and clarified the rules governing the three business tax regimes: the C Corporation, the S Corporation and the partnership. Notwithstanding the many changes that have occurred over the years, the original structure of this casebook still conforms to the current landscape. Although the seventh edition incorporates all relevant changes in the law and new cases and rulings, the overall structure of the book remains the same. Moreover, the philosophy that guided the creation of this book continues to guide the seventh edition. The Preface to the First Edition delineates this philosophy and follows in its entirety. Students are encouraged to examine the Preface to the First Edition carefully and to return to it frequently throughout their course of study. The seventh edition has profited from many helpful comments and suggestions received from colleagues including Sam Brunson, Jose Gabilondo, Christian Johnson, Roberta Mann, Lloyd Mayer, and Denise Roy. I have had valuable student assistance on this edition from Caitlin Bradford, Abbey Heeter, and Aly Reedy. The seventh edition was prepared with knowledge of events reported through September 1, 2022. JEFFREY L. KWALL Chicago, Illinois September 2022 PREFACE TO THE FIRST EDITION Most students using this casebook recently completed a basic law school course in personal income tax. These students probably expect the study of business taxation to differ dramatically from the study of personal income tax. After all, the basic course focused on the taxation of individuals, whereas this casebook addresses the taxation of corporations, partnerships and limited liability companies. In spite of its appearance, however, this casebook draws upon and further develops much of what was learned in the basic income tax course. The basic tax course introduced the fundamental concepts on which the United States system for taxing income is based. These concepts were explored in contexts to which the uninitiated student could most easily relate; namely, the personal and business activities of an individual. This casebook is designed to deepen the student’s understanding of the same fundamental concepts introduced in the basic course. It explores these concepts in the context of issues that arise when a business takes on a legal identity of its own; specifically, when the business is conducted by a corporation, a partnership or a limited liability company. Three alternative tax regimes (“C Corporation”, “S Corporation”, and “partnership”) apply to businesses that are accorded a legal identity separate from their individual owners. The tax regime that applies to a given business depends largely on the legal form in which that business is conducted. Every corporation is taxed as a “C Corporation” or as an “S Corporation”. Most state law partnerships and limited liability companies are governed by the “partnership” tax regime. This casebook deviates from most business tax casebooks by examining the three different tax regimes in an integrated fashion, rather than treating each tax regime as a discrete subject. Several of the major topics explored in this casebook are divided into separate chapters on each tax regime. This approach is intended to encourage a comparison of the three regimes on an ongoing basis. This end may be achieved by studying the chapters in the order presented or, in the alternative, by examining all the chapters that apply to each regime separately and deferring a comparison until later in the course. In either case, a primary goal of the casebook is to foster the ability to compare the tax consequences of all three tax regimes, an ability that has become increasingly important in recent years in light of fundamental reforms that dramatically changed the relative tax costs associated with each of the three tax regimes. This casebook is divided into six parts. Parts One through Four are designed to accommodate a basic business taxation course that examines the fundamentals of the three different tax regimes that apply to business enterprise. Part One (Chapter 1) provides an overview of the different legal forms in which a business may be conducted and the Federal income tax treatment of these different forms. After this overview, Part Two (Chapters 2 through 4) explores how the income of a business is defined and taxed under each of the three alternative tax regimes: C Corporation, S Corporation and partnership. Part Two focuses on the operational stage of the business, rather than adhering to the more traditional approach of beginning with the tax issues that arise when a new business is formed. The casebook begins at the operational stage so that the study of business taxation will parallel the basic personal income tax course which focused on how the income of an individual is defined and taxed. Part Three (Chapters 5 through 7) focuses on the consequences that follow when business profits are physically transferred by the business to its owners. Part Three examines the tax consequences to the business and its owners under each of the three tax regimes when business profits are distributed. After distributions are examined, Part Four (Chapters 8 through 10) explores the tax consequences that result under each of the three tax regimes when value is transferred in the opposite direction; namely, from the owner to the business. Parts Five and Six of the casebook examine a series of more advanced corporate transactional issues. Part Five (Chapters 11 through 14) focuses on the tax consequences that result when a corporate business is disposed of (or acquired) in a taxable sale or a nontaxable reorganization. Part Six (Chapters 15 and 16) addresses the tax consequences that occur when a corporation divests itself of a business or when a corporation’s capital structure or operating entity is modified. While some students may be introduced to the materials in Parts Five and Six in a basic business taxation course, an in-depth examination of these topics normally must be reserved for a more advanced course. The organization of this casebook reflects the fact that choices must be made in terms of how much can be covered in a basic business taxation course. This organization also reflects the judgment that a business lawyer who used this book in law school is more likely to seek the assistance of a tax expert when dealing with an out of the ordinary corporate disposition, acquisition, division or rearrangement, than when counseling a client with respect to the choice of business form, day-to-day operating activities, and transfers of value to and from the business. This casebook is not intended to serve as a comprehensive source of all of the income tax rules that currently apply to business enterprises and their owners. Nor is it intended to analyze in great detail every rule it identifies. Instead, its goal is to examine existing law as a means of furthering the student’s understanding of the underlying fundamental concepts and of refining the student’s ability to master technically complex rules. This approach is taken for two reasons. First, in light of the frequency with which tax legislation has been enacted in recent years, many of the current rules are likely to be changed or refined by the time that students taking this course graduate from law school. In addition, even if the rules do not change, it is unlikely that students will remember in detail many of the technical rules explored in this course after the final exam ends! Consequently, a principal goal of the casebook is to cause the student to raise the right question, rather than to think that he or she knows the right answer. A great deal of care has gone into the selection of cases for inclusion in this casebook. Aside from selecting cases on the basis of each court’s substantive analysis, many cases were chosen to expose students to practical problems that arise in the conduct of a business. Taxation is a highly practical endeavor and those students who have not been exposed to real world business decisions can learn from the events described in these cases. Other cases demonstrate how a lawyer who counsels a client in connection with a business transaction can create serious tax problems for the client if the lawyer is inadequately versed in the tax law. Hopefully, these cases will alert those students who do not specialize in taxation of the importance of knowing when to seek the assistance of a more knowledgeable professional. Most of the explanatory materials in this casebook are developed in the notes that follow the cases and rulings, rather than provided in advance of the cases and rulings. This approach is intended to enable the student to think independently about the particular issues explored in the case or ruling before editorial discussion is provided to help channel the student’s thinking. Examples and problems are included where appropriate, though an effort has been made not to stress mechanics to the point that the inevitable uncertainties of the law become obscured. Most of the cases and rulings reproduced in this casebook have been heavily edited with the deletions indicated by asterisks. Many of the original footnotes in the cases have been deleted and those that remain are numbered consecutively, rather than preserving the original numbering from the case. Editorial additions are designated as such. I owe gratitude to many individuals. I thank Stuart Duhl for teaching me how to put the tax law into perspective. I thank Alan Gunn for continuously offering thoughtful insights and suggestions over the entire course of this project. I thank Loretta Argrett, Evelyn Body, Patricia Bryan, Glenn Coven, Mary Ferrari, Stuart Filler, Christine Manolakas, William Popkin, Philip Postlewaite, George Yin and Lawrence Zelenak for many helpful comments and suggestions. I thank Dean Nina Appel, Associate Dean Thomas Haney and my colleagues and friends at Loyola University Chicago School of Law and at Schwartz & Freeman for their interest and encouragement. Gratitude is also expressed to Loyola University Chicago for research support. For invaluable research and editorial assistance, I thank Sally Joyce, Tom Thesing, Sara Fiedler, Jamie Goldman, Linda Hanes, Ginger Heyman, Eileen Rosen, Candyce Wilson, David Buckley, William Hahn, Lauri Aldrich, Jim Montague, and Matt Bryant. Appreciation is also expressed to all of the students who were taught from earlier drafts of this work. Thanks to Patricia Hallen for secretarial assistance. I also wish to lovingly thank my wife, Bobbi, and my daughters Shanna, Rachel and Nisa for tolerating my obsession with this project. Finally, I encourage students not to view the road ahead as a dry and dusty one. Many students probably approached the personal income tax course with dread, yet found the experience to be quite stimulating. Most (all?) students should find the taxation of business enterprise to be at least as satisfying. With this expectation, let us begin. JEFFREY L. KWALL Chicago, Illinois September, 1994 SUMMARY OF CONTENTS PREFACE TO THE SEVENTH EDITION PREFACE TO THE FIRST EDITION TABLE OF CASES TABLE OF STATUTES TABLE OF REGULATIONS TABLE OF I.R.S. RULINGS TABLE OF AUTHORITIES PART ONE. INTRODUCTION Chapter 1. Perspective A.The Business as an Entity Under State Law B.The Business as a Taxpaying Entity—the C Corporation C.The Business as a Tax Accounting Entity—the S Corporation and the Partnership D.The Uniform Taxation of All Business Income—Preview of the Future? PART TWO. OPERATIONS Chapter 2. C Corporation Operations A.Corporate Income Tax B.Corporate Penalty Taxes C.Consequences of Operating Loss D.Distinguishing Corporation from Shareholders Chapter 3. S Corporation Operations A.Computation of Gross Income and Deductions B.Allocation to Shareholders C.Deduction for Qualified Business Income D.Consequences of Operating Loss E.Distinguishing S Corporation from C Corporation F.Transitional Problems Chapter 4. Partnership Operations A.Computation of Gross Income and Deductions B.Allocation to Partners C.Deduction for Qualified Business Income D.Allowance of Allocated Deduction/Loss E.Modifying an Allocation F.Distinguishing Partnership from Proprietorship G.Distinguishing Partnership from Taxpaying Entity PART THREE. DISTRIBUTIONS Chapter 5. C Corporation Distributions A.One-Side Distribution B.Redemption C.Liquidation D.Sale of C Corporation Chapter 6. S Corporation Distributions A.One-Side Distribution
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