Intangibles Tax on LLC Interests
Members of limited liability companies (“LLCs”) are sometimes surprised to realize that the member interests are subject to the annual Florida Intangible Personal Property Tax (“Intangibles Tax”). Many who used to hold real estate investments personally now hold them in LLCs, to take advantage of liability protection. But as a consequence, the LLC pays ad valorem real estate taxes and the members pay Intangibles Tax on the member interests. Where there used to be a single asset tax, now there are two.
Advantages of an LLC.
For many reasons, limited liability companies have become a popular entity choice. The interest of a member of a Florida LLC (assuming two or more members) cannot be levied on and sold by a creditor of the member. The interest is subject only to a “charging order,” whereby the creditor is entitled only to receive distributions of cash paid with respect to the interest. The ownership of the interest, and the management rights, remain with the owner. This is in contrast to corporate stock, for example, where a creditor can levy on and force a sale of the stock, thereby causing divestiture of ownership and all economic and management rights possessed by the stock.
A Florida LLC provides its members with the same degree of protection from creditors of the company that a Florida corporation would offer to its shareholders. Members cannot withdraw at will from an LLC (which a partner could do if, for example, a limited liability partnership were used).
For a wide variety of business and investment activities, many practitioners have recommended using an LLC which elects to be taxed as an S corporation (So-called “check the box” elective federal tax treatment has been available since 1997.). This structure is sometimes called the “LLC envelope.” It is popular because it generally offers all the advantages of an S corporation but provides its members superior protection from their creditors than if they owned corporate stock. To elect to be taxed as an S corporation, various eligibility requirements must be satisfied. If it so elects, for the most part it is a “pass through” entity. Distributions to members are generally not subject to Federal Self-Employment Tax (imposed at a rate of 15.3% up to $90,000 and 2.9% above that). A disadvantage of an LLC is that the member interests are subject to the annual Intangibles Tax.
The Intangibles Tax.
The Intangibles Tax is commonly thought of as applying to stocks and bonds, but it applies to other interests as well, including LLC member interests. The Intangibles Tax rate is one million ($1,000 of tax for each $1 million of taxable value), assessed on taxable property owned on January 1 of each year. If there is a failure to pay, the penalties can be significant. If the tax is not paid by June 30, a delinquency penalty of 10% of the tax for each month thereafter is imposed, up to a maximum of 50%. If property is omitted from the return, an additional 10% omitted property penalty applies. Undervaluation is penalized at 10% of the undervaluation. In addition, interest accrues on any deficiency.
The tax is imposed on the fair market value of the member interests. In reference to corporate stock, which is similarly viewed, the Department of Revenue instructions state: “Book value is not an acceptable method of valuing closely-held stock for intangible tax purposes.” In valuing stock or member interests, the Florida Administrative Code requires that consideration be given to “the company’s value of goodwill or other intangible value.” Therefore, appreciation in value of real estate or other assets held by the company must be considered. Appropriate discounts are allowable, depending on the circumstances in each situation.
The Department of Revenue has become aware that some taxpayers who hold LLC member interests have failed to return such property for Intangibles Tax purposes. We understand that the Department of Revenue is, in some cases, cross-checking the public records of limited liability companies against Intangibles Tax returns filed by LLC members.
Where the Intangibles Tax is significant, it may be preferable not to use an LLC as an entity. One alternative would be a Florida limited liability limited partnership (“LLLP”). The partnership interests in an LLLP are exempt from the Intangibles Tax. The partnership interests apparently enjoy the same protection from creditors of a partner as do LLC member interests. In other words, instead of being subject to levy and sale by a creditor of the member, they are only subject to a charging order. A limited partnership agreement can prohibit a limited partner from withdrawing at will from the LLLP.
A partner’s protection from liability for obligations of an LLLP is based upon a statute similar to the one governing an LLC. However, since the Florida Revised Uniform Limited Partnership Act (1986) does not specifically incorporate the corporate law standard of liability protection, it is presently unclear if the degree of creditor protection in an LLLC is identical to that of a corporation. If creditor protection of an individual general partner of an LLLP is a concern, a corporation can be used as the general partner.
From a tax perspective, if an LLLP makes no tax election, it is taxed for federal purposes as a partnership. Normally, limited partners are exempted by statute from the Federal Self-Employment Tax on distributions received from the partnership. While this protection does not apply to a general partner, techniques are available for mitigating the impact of the tax. Alternatively, an LLLP can “check the box” and elect to be taxed as an S corporation, in which case no Federal Self-Employment Tax normally applies.
In summary, where Intangibles Tax exposure is considerable, an LLLP may be a better choice than an LLC. Always, in making “choice of entity” decisions, other factors must be considered. They include the nature of the business to be carried on, the assets of the entity, the types of owners, the individual tax characteristics of the owners, the debt structure, expectation of losses, and future financing plans. Depending on the facts, a different type of entity could be better.
If an LLC decides that it would be preferable to carry on business as an LLLP, such a change can generally be effected without adverse federal income tax consequences, and without imposition of documentary tax if title to real estate is transferred from the LLC to the LLLP. However, to assure this result, such a transaction must be carefully planned and executed, both with respect to state law and federal tax law.