Help with Crazy Entity Setup

Have a new client - this couple has the craziest entity setup I have ever seen - any suggestions on how to best handle this would be most appreciated!!

Client (married couple) own a C-Corp. The C-Corp in turn owns two different LLC's that have been filing partnership tax returns. The C-Corp is the only member in both of the LLC's. So there lies my first problem, I have two LLC's that have been filing partnership tax returns when in fact they are both a single member LLC's.

Those 2 LLC's purchased a hotel (around $6,000,000; so each LLC owns 50% of a hotel.

So in reality, I think what I have is a C-Corp that owns two disregarded entities that own 6 million in real estate which basically is the same thing as saying the C-Corp owns 6 million in real estate, right?

How do I best clear this mess up? I would like to just not file 1065's and just report everything on the Corp return, make an S-Election on the Corp. But I imagine the IRS would be looking for the partnership tax return since it's been filing partnership returns (I have 5 years of returns and everyone of them was a 1065 with only 1 partner).

Any thoughts?

Did they paper file the 1065s? Every tax prep software I've ever used throws an efile error if you have a 1065 with only one partner.

So in reality, I think what I have is a C-Corp that owns two disregarded entities that own 6 million in real estate which basically is the same thing as saying the C-Corp owns 6 million in real estate, right?

For federal tax purposes, that appears to be what's going on. Depending on the state the SMLLCs may have a separate return.

How do I best clear this mess up? I would like to just not file 1065's and just report everything on the Corp return, make an S-Election on the Corp. But I imagine the IRS would be looking for the partnership tax return since it's been filing partnership returns (I have 5 years of returns and everyone of them was a 1065 with only 1 partner).

Not sure if this is the proper way to do it, but I would stop filing the 1065s (don't file final 1065s), and respond to any IRS notice with a letter or phone call that the LLC is a disregarded entity wholly owned by ABC Corp (EIN: 99-9999999) and included on ABC Corp's tax return.

Do H & W own the C corp. jointly? Not that I think it matters, just curious where they think they were going with their structure.

Does each LLC own a 50% undivided interest in the hotel or is there a de facto or even a de jure partnership?

Same question as ManVs Tax - who is shown as the second partner if each LLC in fact filed a 1065? Or are you saying that the two LLCs filed a 1065 as partners?

Does the operation show a profit or a loss? Can they use the loss (if any) personally? Do they take a salary? Do they receive dividends.

What were they striving to accomplish with the structure (if they even know)? Double layer of liability protection?

LA is a community property state. Does that have something to do with this strangeness? What about that strange French origin thingy you have down there, a usufruct?

H&W won the C corp jointly. They are the only owners of the C-Corp.

The LLC's filed 1065's and show only one partner - the C-Corp. Only one K-1 issued, and on the front page of the 1065 where it asks the number of partners, it clearly says ONE.

Their sister has been doing their taxes, not a tax professional, I have never used an over the counter software for tax prep so I don't know but I'd guess the diagnostics are not quite up to Lacerte's level.

No loss - all of the tax returns show a small profit (20k or less). The crazy set up was for double liability protection & bad advice from an attorney. It has nothing to do with crazy LA laws; in fact to make matters more crazy each of the 3 entities is set up in different states, WHY DO PEOPLE DO THIS???? I do not know - bad advise - the C-Corp is a CA corp; one of the LLC's is Nevada, the other is Delaware. The hotel that is really the only source of income/expense for any of the 3 entities is located in Louisiana.

Prior year is very messed up - the profit from the LLC's flowed through to the 1120 - no balance sheet on the 1120 and no financial stmts. The only expense is rent - yes - I said rent. Apparently the corporation pays rent to the H&W for the use of a building that they use to manage the investments (the 2 LLC's). That's a whole other issue that will be corrected, but my main concern right now is how to fix this going forward.

This is an absolute mess...

Why Louisiana residents were told to form a CA C-Corp and be subject to the $800 minimum CA franchise tax is beyond me when the only activity is a hotel in Louisiana.

This seems like a classic case of pay me now or pay me later. They're going to pay a lot for professionals to sort this mess out and streamline things going forward, when they haven't in the past and may balk at the quote.

Is there some LA tax situation I'm missing that would disincentivize them to have the C-Corp incorporated in LA?

Really I think it would be optimal to hold the real estate asset in an LLC -- either disregarded or pship, and have a separate C-Corp or S-Corp manage the operations with a bona fide contract in place (that's assuming they're actively mangaging and not outsourcing daily management to a third party).

We can't plan backwards so you just have to deal with what's in place now and going forward.

If taxpayer wants to keep the hotel in the C-Corp -- I would stop filing the 1065s as previously mentioned. Respond to an IRS notice with a return letter as I laid out above. Have client talk to an attorney about reorganizing the C-Corp in LA or DE. This will be a cost-benefit analysis (attorney and filing fees vs CA franchise tax).

If there's no legal purpose to the two LLCs wouldn't it be better to merge those two into one LLC? Maybe it's just simpler to keep that that as is with the two filing fees and not deal with title issues, professional fees, re-org fees, etc.

Prior year is very messed up - the profit from the LLC's flowed through to the 1120 - no balance sheet on the 1120 and no financial stmts. The only expense is rent - yes - I said rent. Apparently the corporation pays rent to the H&W for the use of a building that they use to manage the investments (the 2 LLC's). That's a whole other issue that will be corrected, but my main concern right now is how to fix this going forward.

Well, if the assets of the DREs plus the assets of the C-Corp are above $250k, which they definitely appear to be, Question 13 on Sch K of the 1120 should be "no" and Sch L, M-1, and M-2 should be complete.

Technically if the C-Corp has no activity and they've been filing 1065s for the DREs there shouldn't be any of the LLCs expenses on the 1120. They should be on the 1065s and flow through on the K-1s.

Where are they residents? I've not seen that mentioned. And while you're fixing so much, any way to get that real estate out of the corp? Or make an S election at least?

They are residents of CA.
Okay so I think I was on the right track ....
1) Make S-Election on C-Corp
2) Put all income/expenses for hotel on 1120S as the LLC's are disregarded entities - deal with the IRS notice on not filing 1065's when the notice comes in.
3) Have them consult attorney on reorganizing the corp in LA

Sound like a plan?

Sorry, I assumed they were LA residents. If they're CA residents it's less important that the C-Corp is incorporated in CA. CA will argue the C-Corp is doing business in CA if management is located within the state.

I think you're heading in the right direction, Kathy. Yes, CA will want their share since folks are CA residents...surely they credit for LA taxes paid? I think I would try to make a LA corp out of it, S corp election, and let the income flow thru to CA personal. If you go the other way with a CA corp, you'll have LA stuff to file anyway, and maybe an extra corp return to boot.

Management (the couple) is located in CA and thus the corp is "doing business in CA".

I don't think you can avoid the CA filing obligation unless the couple leaves CA or perhaps are silent passive investors that have a manager. The corp should be filing CA and LA state returns.