TO: Senior Partner
FROM: LL.M. Team Number __16__
DATE: November 7, 2008
SUBJECT: 2008 Law Student Tax Challenge Problem
I. CLIENT OBJECTIVE
Our client, Bubba Gump Shrimp Company (“BGSC”), seeks to form a business entity
with Imreal Legassy to invest in one of three proposed rehabilitation projects in the New Orleans
area. The three proposals given to BGSC from Singing Saints, LP are as follows:
1. The New Orleans Charter School for the Arts (“NOSCA”)
2. Revitalization Village (“RV”)
3. Big Easy Beignet and Brew (“BBB”)
The initial investment in one of these proposals will be $2,000,000, with subsequent annual
investments of at least $50,000 over the next ten years. The purpose of this investment is to
utilize all available Federal income tax credits, obtain a moderate return on investment, and
genuinely benefit the community at large.
After considering each proposal presented by Singing Saints, it is our recommendation
that BGSC invest in Proposal 2, the Revitalization Village. While Proposals 1 and 3 offer
generous tax advantages, Proposal 2 is the most advantageous and holds the least risk of losing
tax credits based on its stated business purpose. Proposal 3 will probably gain the highest return
on investment; however, it is possible that its operations will not allow for the use of certain tax
credits. Alternatively, Proposal 1 may bring the most benefit to the Ninth Ward community, but
has little opportunity for profit. Ultimately, the combination of tax credits and the steady stream
of income promised by Proposal 2 makes that option the most attractive.
Finally, it is our recommendation that BGSC form a limited liability company (“the
LLC”) with Legassy to affect the investment and allow for the tax credits to flow through to both
BGSC and Legassy. To implement the proposed plan, the LLC will make its investment through
Singing Saints, LP, a community development entity.
II. REVITALIZATION VILLAGE (RV)
RV is designed to be a planned development of eco-friendly single-family homes located
in the Ninth Ward. The development will be constructed by the Foley-Pitt Trust (“Trust”), a
foundation created by two Hollywood celebrities. In addition to constructing the homes, the
Trust will assist new residents in securing financing to purchase the new homes. During the
construction and eventual sale of these homes, the LLC will be eligible to receive the New
Markets Tax Credit and the New Energy Efficient Home Credit.
A. The New Markets Tax Credit
Under §45D of the Internal Revenue Code (“Code”), taxpayers are allowed a new markets
tax credit for qualified equity investments (“QEI”) in a qualified community development entity
(“CDE”). I.R.C. §45D(a) (2006). The investor is allowed a credit equal to five-percent of the
equity investment for the year the equity interest is purchased from the CDE and for each of the
next two years, as well as a six-percent credit for each of the following four years. I.R.C.
§45D(a)(2)-(3) (2006). To determine the credit, the taxpayer applies the applicable percentage to
the amount paid to the CDE for the investment. The credit is available for the taxable year of the
investment and for each year the investor holds the investment on the anniversary date of the
initial investment. I.R.C. §45D(a)(3) (2006).
A qualified CDE is defined as any domestic corporation or partnership if: “(a) the primary
mission of the entity is serving, or providing investment capital for, low-income communities or
low-income persons, (b) the entity maintains accountability to residents of low-income
communities through their representation on any governing board of the entity or on any
advisory board to the entity, and (c) the entity is certified by the Secretary for purposes of this
section as being a qualified CDE.” I.R.C. §45D(d) (2006). A QEI is either stock in a corporation
or an interest in a partnership that is acquired directly from a CDE for cash. I.R.C. §45D(b)(1)
(2006). Substantially all of the cash must be used by the qualified CDE to make qualified low-
income community investments (“QLICI”), and the investments must be designated for purposes
of §45D by the qualified CDE. Id. QLICIs that satisfy the purpose of §45D include (a) capital or
equity investments in, or loans to, qualified active low-income community businesses, (b) certain
financial counseling and other services to businesses and residents in low-income communities,
(c) the purchase from another CDE of any loan made by such entity that is a qualified low-
income community investment, or (d) an equity investment in, or loan to, another CDE.
The Code defines a qualified active low-income community business as a business where; (a)
at least fifty-percent of the total gross income of the business is derived from the active conduct
of trade or business activities in any low-income community; (b) a substantial portion of the
tangible property of such business is used in a low-income community; (c) a substantial portion
of the services performed for such business by its employees is performed in a low-income
community; and (d) less than five-percent of the average aggregate unadjusted basis of the
property of such business is attributable to certain financial property or to certain collectibles.
I.R.C. §45D(d)(2)(A) (2006).
With regards to the requirements above, an investment by the LLC into the Pitt-Foley Trust
will qualify for a New Markets Tax Credit. The Trust is a qualified active low-income
community business, with all of its income derived from the active conduct of business in a low-
income community. All of the Trust’s property is in the same low-income community and all of
its services will be performed within the community. I.R.C. §45D(d)(2)(A) (2006). In order to
satisfy the CDE requirements, the LLC will invest with Singing Saints, who has already been
designated as a CDE and awarded an allocation of credits through the CDFI Fund. An entity
given CDFI status qualifies as a CDE under §45D(c)(2)(B) (2006).
The initial investment of $2,000,000 by the LLC will qualify for a five-percent credit in each
of the first three years, resulting in a $100,000 credit in each of these years. For the next four
years, the investment will receive a six-percent credit, or $120,000 per year. Each subsequent
annual investment of $50,000 would also be given the same credit schedule, resulting in a $2,500
credit for the first three years and $3,000 for the next four years for each respective annual
investment. This would result in a total credit period of 18 years with a total of $975,000 in
credits over that time period. This is thirty-nine percent of the total investment, making the new
market tax credit extremely attractive. These credits are available as long as Singing Saints, and
by extension, the LLC, remains a CDE engaged in community development throughout the
entire eighteen year period.
B. The New Energy Efficient Home Credit
In addition to the new market credit, each of the sustainable and eco-friendly houses being
built by the Trust would qualify for the New Energy Efficient Home Credit. To qualify for the
credit, each newly-constructed home must be constructed by an eligible contractor and acquired
by a person from the eligible contractor during the tax year. I.R.C. §45L(a)(1) (2007). Under
§45L, to qualify as an eligible contractor, one must be the builder of a qualified new energy
efficient home. I.R.C. §45L(b)(1)(A) (2007). The Code defines a qualified new energy efficient
home as a dwelling unit that is located in the United States, built after the enactment of §45L,
that meets the energy saving requirements of §45L(c). This requires certification that the house
will have a level of annual heating and cooling energy consumption at least fifty-percent below
the annual level of heating and cooling energy consumption of a comparable dwelling unit
constructed in accordance with the International Energy Conservation Code and for which the
heating and cooling equipment efficiencies correspond to the minimum allowed under the
National Appliance Energy Conservation Act of 1987. I.R.C. §45L(c)(1) (2007). Additionally, at
least one fifth of the fifty-percent energy reduction must be attributable to insulation materials or
systems specifically and primarily designed to reduce heat loss or gain, exterior windows
(including skylights), doors, and any duct sealing and infiltration reduction measures. I.R.C
§45L(c)(3) (2007). A new home that qualifies under this section will be allowed a $2,000 credit
to the contractor in the taxable year that the home is constructed in.
Although the language of §45L indicates that the new energy efficient home credit sunsets on
December 31, 2008, the Emergency Economic Stabilization Act of 2008 extends the credit to all
homes constructed before December 31, 2009. Pub. L. No. 110-343, Div. B, Sec. 304 (2008).
Assuming that the Trust requires its eco-construction firm to follow the guidelines set forth in
§45L when constructing the RV homes, each home should qualify for a $2,000 credit in the tax
year that it is constructed. In order to ensure this credit’s availability, we suggest adding a term
to the partnership investment agreement with Singing Saints and the Trust, requiring that all
homes built in the RV will be certifiable under §45L(c) of the Code. Without knowing exactly
how many homes the Trust plans to build initially, it is impossible to determine the exact amount
of credit the LLC may receive. However, for each home built in RV, the LLC should receive a
pro-rata share of the $2,000 credit according to its interest in the Trust. Note, however, that every
home receiving the $2000 credit must undergo a corresponding $2000 basis reduction. The effect
is increased gain on the sale of the homes.
III. BIG EASY BEIGNET AND BREW (BBB)
The BBB provides BGSC and Legassy with a clear opportunity for return on investment;
however, many of the special deductions created by congress to spur investment in the Gulf
Opportunity Zone will likely have expired by the time Singing Saints and the LLC are ready to
take action on the proposal.
BBB is already an established brand in New Orleans and will most likely provide the largest
profit of the three Singing Saints proposals. However, its principal business, brewing beer for
shipment across the country, will probably disqualify it for the New Markets Tax Credit. As
described above, the New Markets Tax Credit would allow for a thirty-nine-percent tax credit
over the eighteen year taxable period from initial investment. The credit requires a CDE, like
Singing Saints, to invest in a qualified business. While BBB is certainly an active business in a
low-income community, it is engaged in an activity that would exclude it from the benefits of
§45D. Under the Regulations, qualified business does not include any store where the principal
business is the sale of alcoholic beverages for the consumption off premises. Treas. Reg. §
1.45D-1(d)(5) (2005). While this would seem to deny the credit, it will not deny it completely.
The Regulations do allow a business to separate the parts that do not comply with the Code and
claim a credit for the portion of the business that does comply. Treas. Reg. § 1.45D-1(d)(4)(iii)
(2005). To take advantage of the credit, we can insulate the brewery portion of BBB by
separately incorporating it and taking a credit for the portion of profits derived from BBB’s non-
brewery business. As an alternative, we can suggest that the sale of alcoholic beverages for off
premises consumption be limited, such that the treasury regulations for §45D are not violated.
Additional tax benefits are available in the form of deductions for investment in the Gulf
Opportunity Zone (“GO Zone”). I.R.C. §§ 1400M-1400T (2005). According to IRS Notice 2005-
92, New Orleans, including the 9th Ward, is situated within the GO Zone. As a result, attractive
tax benefits are available for businesses such as BBB. However, many of the available
deductions are set to sunset on December 31, 2008 or earlier. Presumably, our client will be
unable to take advantage of many of these deductions given the current timing. Regardless,
several opportunities remain.
Construction of BBB’s new 9th Ward facility will result in large depreciation deductions to
BBB. In addition to the standard depreciation deduction allowed under §167(a), Qualified GO
Zone property is entitled to an additional depreciation allowance of fifty-percent of the adjusted
basis of the property. I.R.C. §1400N(d)(1)(A) (2005). §1400N(d)(2) provides a definition of the
term Qualified Gulf Opportunity Zone Property (“GO Zone Property”). The types of property
that qualify for special treatment are MACRS property with a recovery period of 20 years or less,
certain computer software, water utility property, qualified leasehold improvement property,
nonresidential real property, residential rental property, or public utility property. The property
must be substantially used in the GO Zone (80% of the time) in the active conduct of a trade or
business, and it must have been purchased after August 28, 2005, and placed in service before
December 31, 2008. I.R.C §1400N(d)(2) (2005), I.R.S. Notice 2006-77. In the case of
nonresidential real property, §1400(d)(6) extends the date placed in service requirement to
December 31, 2010. However, property is not qualified GO Zone property if the principal
business consists of the sale of liquor for off premises construction. I.R.C. § 1400N(p)(3)(A)(i)
Provided BBB takes the same precautions necessary to preserve the new markets tax credit
(as explained above), the building to be used in the 9th Ward BBB and most other tangible
property to be used in that business is qualified GO Zone property within the meaning
§1400N(d). The brewery is nonresidential real property to be located in the 9th ward and its
intended use is in an active trade or business. If the property is purchased and placed in service
prior to December 31, 2010, BBB’s developers will be able to take advantage of the bonus
depreciation. If the LLC’s investment entitles it to its fair share of losses and deductions from the
operations of BBB, this could generate tremendous tax savings for our client in the first few
years of operations. However, due to the ambiguity of a “20% profits interest,” it is not certain
that the LLC will be entitled to any share of losses or deductions.
It is important to note that under §1400N(d)(6)(B)(ii)(II), in the case of a taxpayer who puts
qualified GO Zone nonresidential real property into service on or before December 31, 2010, the
bonus depreciation allowance applies to all other qualified property described above, if
substantially all of the use of such property is within the aforementioned building and the
property is put into service no later than 90 days after the date on which the nonresidential real
property is put into service. Essentially, this allows for fifty-percent bonus depreciation of almost
all property used on the premises of the trade or business. This is significant because the bonus
depreciation provision of §1400N(d) expires for most forms of property in 2008.
We would suggest that in order for an investment in BBB to be worthwhile, the LLC must be
entitled to its fair share of losses and deductions. The uncertainty regarding the ability of our
client to take advantage of the available deductions and potential first year losses, coupled with
the uncertainty regarding the availability of the New Markets Tax Credit leads us to conclude
that the RV is the safer option to take.
IV. NEW ORLEANS CHARTER SCHOOL FOR THE ARTS (NOSCA)
The NOSCA proposal allows for significant tax benefits, but does not provide for any
general profitability. Like the RV and perhaps BBB, NOSCA will qualify for the New Markets
Tax. The Code makes a special exception regarding the New Markets Tax Credit for
organizations operating as 501(c)(3) non-profits. These organizations are deemed to be qualified
businesses for the purpose of the New Market Tax Credit. Treas. Reg. 1.45D-1(d)(4)(i) (2005).
With this exception, NOSCA will be able to take advantage of the New Markets Tax Credit and
provide our investors with a thirty-nine-percent credit as explained above.
Additionally, NOSCA would possibly be able to take advantage of the Rehabilitation
Credit in §47 of the Code. However, this would require that the building was originally placed
in service before 1936. Without additional information about the site they plan to use, we cannot
advise the LLC to pursue this proposal.
Our client made it clear that he wishes to aid the greater New Orleans area, and NOSCA
certainly does that. However, he also asked us to find a proposal that would take advantage of
tax benefits while also realizing a profit and NOSCA is not going to realize a profit. We would
advise our client not to seek this proposal out further. It provides significant tax credits, but RV
provides a similar amount of credit with a likely profit on the sale of homes.
ENTITY FORMATION AND INVESTMENT
BGSC and Legassy will form a limited liability company (LLC) for the purpose of
investing their capital. An LLC is the preferred entity in this situation because it allows for pass-
through of tax items as well as providing limited liability to all of its members. BGSC will
contribute $1,600,000 in cash and $500,000 of stock at the time of formation. The stock has an
adjusted basis of $250,000. Legassy will contribute real property worth $500,000 and future
profits from his sauce and spice business in the amount of $750,000. The real property
contributed has an adjusted basis of $2,500,000 notwithstanding depreciation. The file states that
it is our aim to convert these contributed items to cash for immediate investment. To that end, the
LLC will sell the stock and the contributed building. Upon completion of these sales, BGSC will
be allocated $250,000 of capital gain and an interest in the LLC worth $2,100,000. Upon
immediate sale of Legassy’s building, we can disregard any depreciation deductions that Legassy
has made prior to contributing and allocate loss on the sale of the property to him. I.R.C.
§704(c)(1)(A) (2004). The building has a fair market value of $500,000 and liability of
$550,000, bringing Legassy’s basis in the building to $0 on the sale as the LLC assumes the
liability and the sale proceeds. The $50,000 of outstanding liability on the mortgage will be
attributed and then deducted from Legassy’s basis in the partnership. Treas. Reg. § 1. 752-1(f)
(2005). With the additional contribution of $750,000 in future profits, Legassy will have a
$700,000 basis in his LLC interests. This would result in a total value of $2,800,000 in the LLC,
where BGSC will own seventy-five-percent of LLC interests and Legassy will own twenty-five
percent. This allows our client, BGSC, to take seventy-five percent of the tax credits allocated to
the LLC each year. Treas. Reg. §1.704-1(b)(4)(ii) (2008).
Based on the reasons stated above and the favorable percentage of allocation of tax
credits to BGSC; we conclude that forming an LLC that liquidates the contributed property
immediately and then uses that capital to invest in the Revitalization Village will provide our
client with the most favorable tax benefits while also providing valuable service to the citizens of
the Ninth Ward.
LAW OFFICES OF LL.M. TEAM NUMBER __16___
Tax Town, ABA State, 10000
Tax Town, ABA State, 10000
Based on our careful consideration of the proposals presented to you by Singing Saints,
LP, we recommend that you form a limited liability company to invest in the Revitalization
WHY A LIMITED LIABILITY COMPANY?
Over the past decade and a half, every state has enacted a Limited Liability Company, or
LLC, law to enable residents to use this advantageous business entity. Prior to the advent of
LLCs, people were generally left with three options; a partnership, a C corporation, or an S
corporation. Each had their pros and cons. Partnerships and S corporations were able to avoid the
double-tax that corporate shareholders in a C corporation were subject to. In a C Corporation,
earnings and profits are taxed once at the corporate level and a second time at the shareholder
level whenever a distribution is made to the shareholders from the corporation’s earnings and
profits. Partnerships and S corporations avoided this treatment by passing through gains and
losses directly to partners or shareholders. However, a partnership’s individual partners did not
receive limited liability like the shareholders of a C or S corporation. Additionally, S
corporations prohibit corporate shareholders and have a rigid structure for doling out income and
losses. The LLC changed all of this by allowing for the same tax treatment that a partnership
gets, while affording members of the LLC the same limited liability that a corporation’s
shareholders and officers receive. By using an LLC to structure your investment with Mr.
Legassy, we can modify the way that income, losses, deductions and tax credits are apportioned,
while also providing you and Mr. Legassy with limited liability.
HOW THE LLC WILL WORK IN THIS INVESTMENT
The LLC will be our vehicle for making the investment with Singing Saints. After you
and Mr. Legassy contribute property to the LLC, it will be sold to build capital for your
investment. When the property is sold, each of you will then have a capital account that reflects
how much income and tax credits you receive from the LLC. In addition, you will then have a
basis in the amount of the LLC that you own. When the LLC is formed, your member interest
will be 75% of the LLC's net value and Legassy's will be 25%.
As we mentioned above, an LLC will allow tax credits to pass directly through to you
and Mr. Legassy. In order to comply with the law, an LLC will allocate its tax credits along with
the percentage of ownership. You will be able to receive 75% of the tax credits the LLC
receives. As this flows through to you, and by extension, BGSC, you can use those as a direct
credit against your Federal income tax burden in that particular year.
WHY INVEST IN REVITALIZATION VILLAGE?
We recommend an investment in proposal two, the Revitalization Village (“RV”),
because of the combination of tax credits that will inure as a result of your investment, the
expected profitability of the venture, and the general benefit to the community of providing
affordable and eco-friendly housing.
In assessing the tax benefits of a proposed investment, it is important to understand the
difference between a tax credit and a deduction. A credit results in a dollar-for-dollar reduction
in tax liability. On the other hand, a tax deduction is a reduction of a taxpayer’s total income that
decreases the amount of money used in calculating the tax due. Thus, a $1000 credit is more
valuable than a $1000 deduction.
By investing in RV, you will be able to take advantage of the substantial New Markets
Tax Credit (“NMTC”), as well as the New Energy Efficient Home Credit. We expect that the
NMTC by itself will result in $975,000 of tax credits for the LLC over a total credit period of 18
years, seventy-five-percent of which ($731,250) will flow directly to you. In the first year of the
investment alone, the LLC will be able to take a $100,000 tax credit ($75,000 for you
personally). The way the NMTC works is that through your investment in a “qualified
community development entity,” such as Singing Saints, LP, the LLC will be able to receive a
credit equal to 5% of the LLC’s initial investment in each of the first three years of the
investment. For the next four years, the LLC will be entitled to an annual credit equal to 6% of
the initial investment. Investment in revitalization village also requires subsequent annual
investments of no less than $50,000. Each of these annual contributions is creditable in the same
manner as the LLC’s initial investment. Assuming the LLC contributes $2,000,000 at the outset
and the minimum $50,000 every year for the next ten years, the end result is a total credit equal
to 39% of the overall investment. Given BGSC’s sizable income, you will undoubtedly be able
to take advantage of the full credit available.
Your investment in RV will also allow you take advantage of the New Energy Efficient
Home Credit. Provided the proposed houses are built according to government specifications,
and provided the Pitt-Foley Trust ensures that it meets the Internal Revenue Code’s definition of
“qualified contractor,” the trust should receive a $2000 on every home sold before the close of
the calendar year of 2009. Although we do not have exact projections on the number of homes
the Trust expects to manufacture and sell in the upcoming year or beyond, we believe that the
market for affordable housing in the 9th Ward is strong, which should result in strong
profitability for the foreseeable future.
The first Proposal, the New Orleans Charter School for the Arts, has available to it the
same New Markets Tax Credit as RV, and perhaps a credit for qualified rehabilitation if the
school building is old enough. However, from a profit-making standpoint, we see no benefit in
investment in this proposal.
On the other hand, Big Easy Beignet and Brew (“BBB”) has substantial profit potential
(indeed it has been highly profitable at its original location), but the tax benefits of such an
investment are questionable. Because a primary portion of the proposed business of BBB
involves the sale of alcohol for off premises consumption, the New Markets Tax Credit is
jeopardized, as well as certain tax benefits created by congress. Congress allows a business to
take deductions that reflect the normal wear and tear of assets used in a trade or business. This is
referred to as depreciation, and Congress increased the amount of first-year depreciation
allowable to spur investment in the areas affected by Hurricanes Katrina, Rita and Wilma.
Generally, the brewery itself and the tangible property therein would qualify for this bonus
depreciation. However, because of the nature of BBB’s business, such deductions are likely to be
disallowed by the IRS.
For the following reasons we recommend that you make your investment in the
Revitalization Village. If you have any further questions, or there is something that you do not
understand, please do not hesitate to contact us. Thank you.
LL.M. TEAM NUMBER ___16____