FEDERAL INCOME TAX CONSEQUENCES OF OWNING OUR UNITS
This section of the prospectus describes some of the more important federal
income tax risks and consequences of your participation in our company. No
information regarding state and local taxes is provided. EACH PROSPECTIVE MEMBER
SHOULD CONSULT HIS OR HER OWN TAX ADVISOR CONCERNING THE IMPACT THAT HIS OR HER
INVESTMENT IN THE COMPANY MAY HAVE ON HIS OR HER FEDERAL INCOME TAX LIABILITY
AND THE APPLICATION OF STATE AND LOCAL INCOME AND OTHER TAX LAWS TO HIS OR HER
INVESTMENT IN THE COMPANY. Although we will furnish unit holders with such
information regarding the Company as is required for income tax purposes, each
unit holder will be responsible for preparing and filing his or her own tax
returns.
The following summary of the tax aspects is based on the Internal Revenue
Code of 1986, as amended (the "Code"), existing Treasury Department regulations
("Regulations"), and administrative rulings and judicial decisions interpreting
the Code. Significant uncertainty exists regarding certain tax aspects of
limited liability companies. Such uncertainty is due, in part, to continuing
changes in federal tax law that have not been fully interpreted through
regulations or judicial decisions. Tax legislation may be enacted in the future
that will affect the company and a unit holder's investment in the company.
Additionally, the interpretation of existing law and
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regulations described here may be challenged by the Internal Revenue Service
during an audit of our information return. If successful, such a challenge
likely would result in adjustment of a unit holder's individual return.
The tax opinion contained in this section and the opinion attached as
Exhibit 8.1 to the registration statement constitutes the opinion of our tax
counsel, Brown, Winick, Graves, Gross, Baskerville & Schoenebaum, P.L.C.,
regarding our classification for federal income tax purposes. An opinion of
legal counsel represents an expression of legal counsel's professional judgment
regarding the subject matter of the opinion. It is neither a guarantee of any
indicated result nor an undertaking to defend any indicated result should that
result be challenged by the Internal Revenue Service. This opinion is in no way
binding on the Internal Revenue Service or on any court of law.
In the opinion attached as Exhibit 8.1 to the registration statement, our
tax counsel has also confirmed as correct their representation to us that the
statements and legal conclusions contained in this section regarding general
federal income tax consequences of owning our units as a result of our
partnership tax classification are accurate in all material respects. The tax
consequences to us and our members are highly dependent on matters of fact that
may occur at a future date and are not addressed in our tax counsel's opinion.
With the exception of our tax counsel's opinion that we will be treated as a
partnership for federal income tax purposes, this section represents an
expression of our tax counsel's professional judgment regarding general federal
income tax consequences of owning our units, insofar as it relates to matters of
law and legal conclusions. This section is based on the assumptions and
qualifications stated or referenced in this section. It is neither a guarantee
of the indicated result nor an undertaking to defend the indicated result should
it be challenged by the Internal Revenue Service. No rulings have been or will
be requested from the IRS concerning any of the tax matters we describe.
Accordingly, you should know that the opinion of our tax counsel does not assure
the intended tax consequences because it is in no way binding on the Internal
Revenue Service or any court of law. The IRS or a court may disagree with the
following discussion or with any of the positions taken by us for federal income
tax reporting purposes, and the opinion of our tax counsel may not be sufficient
for an investor to use for the purpose of avoiding penalties relating to a
substantial understatement of income tax under Section 6662(d). See "FEDERAL
INCOME TAX CONSEQUENCES OF OWNING OUR UNITS-Interest on Underpayment of Taxes;
Accuracy-Related Penalties; Negligence Penalties" below.
Investors are urged to consult their own tax advisors with specific
reference to their own tax and financial situations, including the application
and effect of state, local, and other tax laws, and any possible changes in the
tax laws after the date of this prospectus. This section is not to be
constructed as a substitute for careful tax planning.
Partnership Status
Our tax counsel has opined that, assuming we do not elect to be treated as a
corporation, we will be treated as a partnership for federal income tax
purposes. This means that we will not pay any federal income tax and the unit
holders will pay tax on their shares of our net income. Under recently revised
Treasury regulations, known as "check-the-box" regulations, an unincorporated
entity such as a limited liability company will be taxed as partnership unless
the entity is considered a publicly traded limited partnership or the entity
affirmatively elects to be taxed as a corporation.
We will not elect to be taxed as a corporation and will endeavor to take
steps as are feasible and advisable to avoid classification as a publicly traded
limited partnership. Congress has shown no inclination to adopt legislation that
would jeopardize the tax classification of the many entities that have acted in
reliance on the check-the-box regulations.
As a partnership, if we fail to qualify for partnership taxation, we would
be treated as a "C corporation" for federal income tax purposes. As a C
corporation, we would be taxed on our taxable income at corporate rates,
currently at a maximum rate of 35%. Distributions would generally be taxed again
to unit holders as corporate dividends. In addition, unit holders would not be
required to report their shares of our income, gains, losses, or deductions on
their tax returns until such are distributed. Because a tax would be imposed
upon us as a corporate entity, the cash available for distribution to unit
holders would be reduced by the amount of tax paid, in which case the value of
the units would be reduced.
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Publicly Traded Partnership Rules
To qualify for taxation as a partnership, we cannot be a publicly traded
partnership under Section 7704 of the Internal Revenue Code. Generally,
Section 7704 provides that a publicly traded partnership will be taxed as a
corporation if its interests are:
º •
º Traded on an established securities market; or
º •
º Readily tradable on a secondary market or the substantial
equivalent.
Although there is no legal authority on whether a limited liability company
is subject to these rules, in the opinion of our counsel, it is probable that we
are subject to the publicly traded partnership rules because we elected to be
classified and taxed as a partnership.
We will seek to avoid being treated as a publicly traded partnership. Under
Section 1.7704-1(d) of the Treasury Regulations, interests in a partnership are
not considered traded on an established securities market or readily tradable on
a secondary market unless the partnership participates in the establishment of
the market or the inclusion of its interests in a market, or the partnership
recognizes any transfers made on the market by redeeming the transferor partner
or admitting transferee as a partner.
We do not intend to list the units on the New York Stock Exchange, or the
NASDAQ Stock Market, or any other stock exchange. In addition, our operating
agreement prohibits any transfer of units without the approval of our directors.
Our directors intend to approve transfers that fall within safe harbor
provisions of the Treasury Regulations, so that we will not be classified as a
publicly traded partnership. These safe harbor provisions generally provide that
the units will not be treated as readily tradable on a secondary market, or the
substantial equivalent, if the interests are transferred:
º •
º In "private" transfers;
º •
º Pursuant to a qualified matching service; or
º •
º In limited amounts that satisfy a 2% test.
Private transfers include, among others:
º •
º Transfers by gifts in which the transferee's tax basis in the
units is determined by reference to the transferor's tax basis in
the interests transferred;
º •
º Transfers at death, including transfers from an estate or
testamentary trust;
º •
º Transfers between members of a family as defined in
Section 267(c)(4) of the Internal Revenue Code;
º •
º Transfers from retirement plans qualified under Section 401(a) of
the Internal Revenue Code or an IRA; and
º •
º "Block transfers." A block transfer is a transfer by a unit
holder and any related persons as defined in the Internal Revenue
Code in one or more transactions during any thirty-calendar-day
period of units that in the aggregate represents more than 2% of
the total interests in partnership capital or profits.
Transfers through a qualified matching service are also disregarded in
determining whether interests are readily tradable. A matching service is
qualified only if:
º •
º It consists of a computerized or printed system that lists
customers' bid and/or ask prices in order to match unit holders
who want to sell with persons who want to buy;
º •
º Matching occurs either by matching the list of interested buyers
with the list of interested sellers or through a bid and ask
process that allows interested buyers to bid on the listed
interest;
º •
º The seller cannot enter into a binding agreement to sell the
interest until the 15th calendar day after his interest is
listed, which time period must be confirmable by maintenance of
contemporaneous records;
º •
º The closing of a sale effectuated through the matching service
does not occur prior to the 45th calendar day after the interest
is listed;
º •
º The matching service displays only quotes that do not commit any
person to buy or sell an interest at the quoted price (nonfirm
price quotes), or quotes that express an interest in acquiring an
interest
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without an accompanying price (nonbinding indications of
interest), and does not display quotes at which any person is
committed to buy or sell an interest at the quoted price;
º •
º The seller's information is removed within 120 days of its
listing and is not reentered into the system for at least 60 days
after its deletion; and
º •
º The sum of the percentage interests transferred during the
entity's tax year, excluding private transfers, cannot exceed 10%
of the total interests in partnership capital or profits.
In addition, interests are not treated as readily tradable if the sum of the
percentage of the interests transferred during the entity's tax year, excluding
private transfers, do not exceed 2% of the total interests in partnership
capital or profits. We expect to use a combination of these safe harbor
provisions to avoid being treated as a publicly traded partnership.
Tax Treatment of our Operation Flow-Through Taxable Income and Loss; Use of
Calendar Year
We will pay no federal income tax. Instead, as unit holders, investors will
be required to report on their income tax return their allocable share of the
income, gains, losses, and deductions we have recognized without regard to
whether they receive cash distributions.
Because we will be taxed as a partnership, we will have our own taxable year
that is separate from the taxable years of our unit holders. Unless a business
purpose can be established to support a different taxable year, a partnership
must use the "majority interest taxable year" which is the taxable year that
conforms to the taxable year of the holders of more than 50% of its interests.
In this case, the majority interest taxable year is the calendar year.
Tax Consequences to Our Unit Holders
As a unit holder, for your taxable year with which or within which our
taxable year ends you will be required to report on your own income tax return,
your distributive share of our income, gains, losses and deductions regardless
of whether you receive any cash distributions. To illustrate, a unit holder
reporting on a calendar year basis will include his or her share of our 2004
taxable income or loss on his or her 2004 income tax return. A unit holder with
a June 30 fiscal year will report his share of our 2004 taxable income or loss
on his income tax return for the fiscal year ending June 30, 2005. We will
provide each unit holder with an annual Schedule K-1 indicating such holder's
share of our income, loss and separately stated components.
Tax Treatment of Distributions
Distributions made by us to a unit holder generally will not be taxable to
the unit holder for federal income tax purposes as long as distributions do not
exceed the unit holder's basis in his units immediately before the distribution.
Cash distributions in excess of unit basis, which is unlikely to occur, are
treated as gain from the sale or exchange of the units under the rules described
below for unit dispositions.
Initial Tax Basis of Units and Periodic Basis Adjustments
Under Section 722 of the Internal Revenue Code, investors' initial basis in
the units investors purchase will be equal to the sum of the amount of money
investors paid for investors' units. Here, an investor's initial basis in each
unit purchased will be $1,100.
An investor's' initial basis in the units will be increased to reflect the
investor's distributive share of our taxable income, tax-exempt income, gains,
and any increase in the investor's share of recourse and qualified non-recourse
indebtedness. If the investor makes additional capital contributions at any
time, the adjusted basis of the investor's units will be increased by the amount
of any cash contributed or the adjusted basis in any property contributed if
additional units are not distributed to investors.
The basis of an investor's units will be decreased, but not below zero, by:
º •
º The amount of any cash we distribute to the investors;
º •
º The basis of any other property distributed to the investor; and
º •
º The investor's distributive share of losses and nondeductible
expenditures that are "not properly chargeable to capital
account"; and
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º •
º Any reduction in the investor's share of certain items of Company
debt.
The unit basis calculations are complex. A member is only required to
compute unit basis if the computation is necessary to determine his tax
liability, but accurate records should be maintained. Typically, basis
computations are necessary at the following times:
º •
º The end of a taxable year during which we suffered a loss, for
the purpose of determining the deductibility of the member's
share of the loss;
º •
º Upon the liquidation or disposition of a member's interest, or
º •
º Upon the non-liquidating distribution of cash or property to an
investor, in order to ascertain the basis of distributed property
or the taxability of cash distributed.
Except in the case of a taxable sale of a unit or the Company's liquidation,
exact computations usually are not necessary. For example, a unit holder who
regularly receives cash distributions that are less than or equal to his or her
share of our taxable income will have a positive unit basis at all times.
Consequently, no computations are necessary to demonstrate that cash
distributions are not taxable under Section 731(a)(1) of the Internal Revenue
Code. The purpose of the basis adjustments is to keep track of a member's tax
investment in us, with a view toward preventing double taxation or exclusion
from taxation of income items upon ultimate disposition of the units.
Tax Credits to Unit Holders
Small Ethanol Producer Tax Credit
"Small Ethanol Producers" are allowed a 10-cents-per-gallon production
income tax credit on up to 15 million gallons of production annually. Under
current law, small ethanol producers are those ethanol producers producing less
than 30 million gallons per year. Based upon the opinion of our counsel, we do
not expect to be classified as a small ethanol producer for purposes of the tax
credit because we expect to produce approximately 35 million gallons of ethanol
per year.
Although we do not qualify to receive the credit under current law, federal
tax legislation has been introduced, which, if enacted, would change the
definition of a "Small Ethanol Producer." Specifically, producers producing up
to 60 million gallons of ethanol per year would become eligible to receive the
credit. If the tax legislation were enacted, we would expect to become able to
receive the credit for our first 15 million gallons of annual production. If we
do become eligible to receive the credit, because we expect to be classified as
a partnership for tax purposes, we would expect to pass the tax credits through
to our unit holders. Unit holders would then be able to report and utilize the
tax credits on their own income tax returns. However, there is no assurance that
the tax legislation will be passed by the Congress or enacted into law by the
President.
Under current law, the small ethanol producer tax credit is a "passive"
credit. This means that unit holders will be able to utilize the tax credits
only to reduce the tax on passive activity income. See "FEDERAL INCOME TAX
CONSEQUENCES OF OWNING OUR UNITS-Passive Activity Income" on page 72. Although
we would generate passive income for our unit holders, there can be no assurance
when, if ever, we will generate passive income allowing the use of credits.
Further, each unit holder may have other sources of passive activity income or
loss that will affect the ability to utilize the credits. Unused credits may be
carried forward to offset tax on passive activity income in future years.
However, if the proposed tax legislation were enacted, unit holders would be
allowed to utilize the tax credits to reduce their tax on income from other than
passive sources. However, there is no assurance that the tax legislation will be
passed by the Congress or enacted into law by the President.
Under current law, the small ethanol producer tax credit does not apply to
reduce the alternative minimum tax, "AMT." As a result, although the tax credit
may otherwise apply, certain unit holders may not realize the full benefit of
the tax credit due to the application of the AMT. The American Jobs Creation Act
of 2004 changed the tax law for tax years beginning after December 31, 2004 to
allow the credit to reduce the AMT.
Under current law, unit holders utilizing the small ethanol producer tax
credit would be required to increase taxable income by the amount of the credit
in their gross income before utilizing the credit to reduce any tax on their
passive income. This means that although the credits may reduce the tax
liability resulting from a unit holder's passive income, the net result would
not reduce the unit holder's total tax liability on a dollar-for-dollar basis.
Instead, the net-benefit would be a lesser amount. Unit holders in higher
marginal income tax brackets generally would benefit less than unit holders in
lower marginal tax brackets. The proposed tax legislation, if
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enacted, would repeal the present rule requiring the amount of the credit to be
included in income. However, there is no assurance that the tax legislation will
be passed by the Congress or enacted into law by the President.
The small ethanol producers tax credit originally scheduled to expire in
2007 has been extended through 2010. Although Congress may further extend or
make permanent the credit, there is no assurance that the tax credit will be
extended beyond 2010.
Deductibility of Losses; At-Risk Passive Loss Limitations
Generally, a unit holder may deduct losses allocated to him, subject to a
number of restrictions. An investor's ability to deduct any losses we allocate
to the investor is determined by applying the following three limitations
dealing with basis, at-risk and passive losses:
º •
º Basis. An investor may not deduct an amount exceeding the
investor's adjusted basis in the investor's units pursuant to
Internal Revenue Code Section 704(d). If the investor's share of
the Company's losses exceed the investor's basis in the
investor's units at the end of any taxable year, such excess
losses, to the extent that they exceed the investor's adjusted
basis, may be carried over indefinitely and deducted to the
extent that at the end of any succeeding year the investor's
adjusted basis in the investor's units exceeds zero.
º •
º At-Risk Rules. Under the "at-risk" provisions of Section 465 of
the Internal Revenue Code, if an investor is an individual
taxpayer, including an individual partner in a partnership, or a
closely-held corporation, the investor may deduct losses and tax
credits from a trade or business activity, and thereby reduce the
investor's taxable income from other sources, only to the extent
the investor is considered "at risk" with respect to that
particular activity. The amount an investor is considered to have
"at risk" includes money contributed to the activity and certain
amounts borrowed with respect to the activity for which the
investor may be liable.
º •
º Passive Loss Rules. Section 469 of the Internal Revenue Code may
substantially restrict an investor's ability to deduct losses and
tax credits from passive activities. Passive activities generally
include activities conducted by pass-through entities, such as a
limited liability company, certain partnerships, or S
corporations, in which the taxpayer does not materially
participate. Generally, losses from passive activities are
deductible only to the extent of the taxpayer's income from other
passive activities. Passive activity losses that are not
deductible may be carried forward and deducted against future
passive activity income or may be deducted in full upon
disposition of a unit holder's entire interest in us to an
unrelated party in a fully taxable transaction. It is important
to note that "passive activities" do not include dividends and
interest income that normally is considered to be "passive" in
nature. For unit holders who borrow to purchase their units,
interest expense attributable to the amount borrowed will be
aggregated with other items of income and loss from passive
activities and subjected to the passive activity loss limitation.
To illustrate, if a unit holder's only passive activity is our
limited liability company, and if we incur a net loss, no
interest expense on the related borrowing would be deductible. If
that unit holder's share of our taxable income were less than the
related interest expense, the excess would be nondeductible. In
both instances, the disallowed interest would be suspended and
would be deductible against future passive activity income or
upon disposition of the unit holder's entire interest in our
limited liability company to an unrelated party in a fully
taxable transaction.
Passive Activity Income
If we are successful in achieving our investment and operating objectives,
investors may be allocated taxable income from us. To the extent that an
investor's share of our net income constitutes income from a passive activity,
as described above, such income may generally be offset by the investor's net
losses and credits from investments in other passive activities.
Alternative Minimum Tax
If we adopt accelerated methods of depreciation, it is possible that taxable
income for Alternative Minimum Tax purposes might exceed regular taxable income
passed through to the unit holders. No decision has been made on this point, but
we believe that most unit holders are unlikely to be adversely affected by
excess alternative minimum taxable income.
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Allocations of Income and Losses
Your distributive share of our income, gain, loss, or deduction for federal
income tax purposes generally is determined in accordance with our operating
agreement. Under Section 704(b) of the Internal Revenue Code, however, the IRS
will respect our allocation, or a portion of it, only if it either has
"substantial economic effect" or is in accordance with the "partner's interest
in the partnership." If the allocation or portion thereof contained in our
operating agreement does not meet either test, the IRS may reallocate these
items in accordance with its determination of each member's economic interest in
us. Treasury Regulations contain guidelines as to whether partnership
allocations have substantial economic effect. The allocations contained in the
operating agreement are intended to comply with the Treasury Regulations' test
for having substantial economic effect. New unit holders will be allocated a
proportionate share of income or loss for the year in which they became unit
holders. The operating agreement permits our directors to select any method and
convention permissible under Internal Revenue Code Section 706(d) for the
allocation of tax items during the time any person is admitted as a unit holder.
In addition, the operating agreement provides that upon the transfer of all or a
portion of a unit holder's units, other than at the end of the fiscal year, the
entire year's net income or net loss allocable to the transferred units will be
apportioned between the transferor and transferee.
Tax Consequences Upon Disposition of Units
Gain or loss will be recognized on a sale of our units equal to the
difference between the amount realized and the unit holder's basis in the units
sold. The amount realized includes cash and the fair market value of any
property received plus the member's share of our debt. Although unlikely, since
debt is included in an investor's basis, it is possible that an investor could
have a tax liability upon the sale of the investor's units that exceeds the
proceeds of sale.
Gain or loss recognized by a unit holder on the sale or exchange of a unit
held for more than one year generally will be taxed as long-term capital gain or
loss. A portion of this gain or loss, however, will be separately computed and
taxed as ordinary income or loss under Internal Revenue Code Section 751 to the
extent attributable to depreciation recapture or other "unrealized receivables"
or "substantially appreciated inventory" owned by us. We will adopt conventions
to assist those members that sell units in apportioning the gain among the
various categories.
Effect of Tax Code Section 754 Election on Unit Transfers
The adjusted basis of each unit holder in his units, "outside basis"
initially will equal his proportionate share of our adjusted basis in our
assets, "inside basis." Over time, however, it is probable that changes in unit
values and cost recovery deductions will cause the value of a unit to differ
materially from the unit holder's proportionate share of the inside basis.
Section 754 of the Internal Revenue Code permits a partnership to make an
election that allows a transferee who acquires units either by purchase or upon
the death of a unit holder to adjust his share of the inside basis to fair
market value as reflected by the unit price in the case of a purchase or the
estate tax value of the unit in the case of an acquisition upon death of a unit
holder. Once the amount of the transferee's basis adjustment is determined, it
is allocated among our various assets pursuant to Section 755 of the Internal
Revenue Code.
A Section 754 election is beneficial to the transferee when his outside
basis is greater than his proportionate share of the entity's inside basis. In
this case, a special basis calculation is made solely for the benefit of the
transferee that will determine his cost recovery deductions and his gain or loss
on disposition of property by reference to his higher outside basis. The
Section 754 election will be detrimental to the transferee if his outside basis
is less than his proportionate share of inside basis.
If we make a Section 754 election, Treasury regulations require us to make
the basis adjustments. In addition, these regulations place the responsibility
for reporting basis adjustments on us. We must report basis adjustments by
attaching statements to our partnership returns. In addition, we are required to
adjust specific partnership items in light of the basis adjustments.
Consequently, amounts reported on the transferee's Schedule K-1 are adjusted
amounts.
Transferees are subject to an affirmative obligation to notify us of their
bases in acquired interests. To accommodate concerns about the reliability of
the information provided, we are entitled to rely on the written representations
of transferees concerning either the amount paid for the partnership interest or
the transferee's basis in the partnership interest under Section 1014 of the
Internal Revenue Code, unless clearly erroneous.
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Our operating agreement provides our directors with authority to determine
whether or not a Section 754 election will be made. Depending on the
circumstances, the value of units may be affected positively or negatively by
whether or not we make a Section 754 election. If we decide to make a
Section 754 election, the election will be made on a timely filed partnership
income tax return and is effective for transfers occurring in the taxable year
of the return in which the election is made. Once made, the Section 754 election
is irrevocable unless the Internal Revenue Service consents to its revocation.
Our Dissolution and Liquidation may be Taxable to Investors, Unless our
Properties are Distributed In-Kind
Our dissolution and liquidation will involve the distribution to investors
of the assets, if any, remaining after payment of all of our debts and
liabilities. Upon dissolution, investors' units may be liquidated by one or more
distributions of cash or other property. If investors receive only cash upon the
dissolution, gain would be recognized by investors to the extent, if any, that
the amount of cash received exceeds investors' adjusted bases in investors'
units. We will recognize no gain or loss if we distribute our own property in a
dissolution. However, since our primary asset will likely be the ethanol plant,
it is unlikely that we will make a distribution in kind.
Reporting Requirements
The IRS requires a taxpayer who sells or exchanges a membership unit to
notify the Company in writing within 30 days, or for transfers occurring on or
after December 16 of any year, by January 15 of the following year. Although the
IRS reporting requirement is limited to Section 751(a) exchanges, it is likely
that any transfer of a Company membership unit will constitute a Section 751(a)
exchange. The written notice required by the IRS must include the names and
addresses of both parties to the exchange, the identifying numbers of the
transferor, and if known, of the transferee, and the exchange date. Currently
the IRS imposes a penalty of $50 for failure to file the written notice unless
reasonable cause can be shown.
Tax Information to Members
We will annually provide each member with a Schedule K-1 (or an authorized
substitute). Each member's Schedule K-1 will set out the holder's distributive
share of each item of income, gain, loss, deduction or credit to be separately
stated. Each member must report all items consistently with Schedule K-1 or, if
an inconsistent position is reported, must notify the IRS of any inconsistency
by filing Form 8062 "Notice of Inconsistent Treatment or Administrative
Adjustment Request" with the original or amended return in which the
inconsistent position is taken.
Audit of Income Tax Returns
The IRS may audit our income tax returns and may challenge positions taken
by us for tax purposes and may seek to change our allocations of income, gain,
loss, and deduction to investors. If the IRS were successful in challenging our
allocations in a manner that reduces loss or increases income allocable to
investors, investors may have additional tax liabilities. In addition, such an
audit could lead to separate audits of an investor's tax returns, especially if
adjustments are required, which could result in adjustments on an investors' tax
returns. Any of these events could result in additional tax liabilities,
penalties and interest to investors, and the cost of filing amended tax returns.
Generally, investors are required to file their tax returns in a manner
consistent with the information returns filed by us, such as Schedule K-1, or
investors may be subject to possible penalties, unless they file a statement
with their tax returns describing any inconsistency. In addition, we will select
a "tax matters member" who will have certain responsibilities with respect to
any IRS audit and any court litigation relating to us. Investors should consult
their tax advisors as to the potential impact these procedural rules may have on
them.
Prior to 1982, regardless of the size of a partnership, adjustments to a
partnership's items of income, gain, loss, deduction, or credit had to be made
in separate proceedings with respect to each partner individually. Because a
large partnership sometimes had many partners located in different audit
districts, adjustments to items of income, gains, losses, deductions, or credits
of the partnership had to be made in numerous actions in several jurisdictions,
sometimes with conflicting outcomes. The Tax Equity and Fiscal Responsibility
Act of 1982 ("TEFRA") established unified audit rules applicable to all but
certain small partnerships. These rules require the tax treatment of all
"partnership items" to be determined at the partnership, rather than the
partner, level. Partnership items are those items that are more appropriately
determined at the partnership level than at the
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partner level, as provided by regulations. Since we will be taxed as a
partnership, the TEFRA rules are applicable to our members and us.
The IRS may challenge the reporting position of a partnership by conducting
a single administrative proceeding to resolve the issue with respect to all
partners. But the IRS must still assess any resulting deficiency against each of
the taxpayers who were partners in the year in which the understatement of tax
liability arose. Any partner of a partnership can request an administrative
adjustment or a refund for his own separate tax liability. Any partner also has
the right to participate in partnership-level administrative proceedings. A
settlement agreement with respect to partnership items binds all parties to the
settlement. The TEFRA rules establish the "Tax Matters Member" as the primary
representative of a partnership in dealings with the IRS. The Tax Matters Member
must be a "member-manager" which is defined as a company member who, alone or
together with others, is vested with the continuing exclusive authority to make
the management decisions necessary to conduct the business for which the
organization was formed. In our case, this would be a member of the board of
directors who is also a unit holder of the company. Our operating agreement
provides for board designation of the Tax Matters Member. Currently, William R.
Pracht is serving as our Tax Matters Member. The IRS generally is required to
give notice of the beginning of partnership-level administrative proceedings and
any resulting administrative adjustment to all partners whose names and
addresses are furnished to the IRS.
Interest on Underpayment of Taxes; Accuracy-Related Penalties; Negligence
Penalties
If we incorrectly report an investor's distributive share of our net income,
such may cause the investor to underpay his taxes. If it is determined that the
investor underpaid his taxes for any taxable year, the investor must pay the
amount of taxes he underpaid plus interest on the underpayment and possibly
penalties from the date the tax was originally due. Under recent law changes,
the accrual of interest and penalties may be suspended for certain qualifying
individual taxpayers if the IRS does not notify an investor of amounts owing
within 18 months of the date the investor filed his income tax return. The
suspension period ends 21 days after the IRS sends the required notice. The rate
of interest is compounded daily and is adjusted quarterly.
Under Section 6662 of the Internal Revenue Code, penalties may be imposed
relating to the accuracy of tax returns that are filed. A 20% penalty is imposed
with respect to any "substantial understatement of income tax" and with respect
to the portion of any underpayment of tax attributable to a "substantial
valuation misstatement" or to "negligence." All those penalties are subject to
an exception to the extent a taxpayer had reasonable cause for a position and
acted in good faith.
The IRS may impose a 20% penalty with respect to any underpayment of tax
attributable to negligence. An underpayment of taxes is attributable to
negligence if such underpayment results from any failure to make a reasonable
attempt to comply with the provisions of the Code, or any careless, reckless, or
intentional disregard of the federal income tax rules or regulations. In
addition, regulations provide that the failure by a taxpayer to include on a tax
return any amount shown on an information return is strong evidence of
negligence. The disclosure of a position on the taxpayer's return will not
necessarily prevent the imposition of the negligence penalty.
State and Local Taxes
In addition to the federal income tax consequences described above,
investors should consider the state and local tax consequences of an investment
in us. This prospectus makes no attempt to summarize the state and local tax
consequences to an investor. Investors are urged to consult their own tax
advisors regarding state and local tax obligations.