Tax 5-1 Identify legal forms or structures a direct participation program may use and the tax and nontax considerations in selecting a form.

Question 1

Direct Participation Programs

Investments have historically been designed to generate tax benefits (subject to certain restrictions) for the investor in the form of losses or credits. These
investments are able to provide these benefits because they are structured to allow investors to participate directly in the income, deductions, and credits of the business. In other words, they are conduit entities.

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Answer 1

Thus the phrase direct participation program often is used to describe these investments. Quite simply, any flow-through entity (limited or general partnership, S corporation, LLC, or LLP) may be referred to as a direct participation program.

Question 2

Direct Participation Programs

The tax advantages provided by direct participation programs are founded upon the principle that most types of business organizations function as _____ conduits.

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Answer 2

tax

That is, while these organizations may function as business entities separate from their owners, they are not separate taxable entities. Rather, items of taxable income, deductible expenses, tax credit, gains, and losses “flow through” the organization to be reported by the individual owners.

Question 3

Direct Participation Programs

The _____ traditionally has been the form most often selected for direct participation investments. It offers the advantage of limited liability for a limited partner/investor. Limited partnerships may be quite large or quite small, with the number of limited partners restricted only by securities registration requirements.

limited partnership

general partnership

master limited partnership

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Answer 3

limited partnership

The disadvantages of this form include the lack of liquidity that most limited partnership interests have and the fact that a limited partner/investor has no voice in management. This is the type of investment historically referred to as a tax shelter.

Question 4

Direct Participation Programs

The _____ form is seldom selected because of the unlimited personal liability of each general partner. When this form is used, the partnership generally is small.

limited partnership

general partnership

master limited partnership

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Answer 4

general partnership

The advantages of this form are that it is relatively simple to organize and each owner/investor may have a significant voice in management.

Question 5

Direct Participation Programs

A _____ is a limited partnership in which units are publicly traded on an established stock exchange.

limited partnership

general partnership

master limited partnership

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Answer 5

master limited partnership

The master limited partnership thus offers the advantage of high liquidity. They are almost always very large. The Omnibus Budget Reconciliation Act of 1987 (OBRA) imposed special rules on the income and losses from publicly traded partnerships. Since 1998, many MLPs have not been treated as a conduit entity. Instead, they have been taxed as corporations.

Question 6

Direct Participation Programs

S corporations sometimes are used as direct participation vehicles, but their use is somewhat limited by the technical requirements for making and maintaining an S election. These technical requirements include the following:

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Answer 6

the maximum number of shareholders is 100;

there are limits on who may be a shareholder;

only one class of stock may be issued;

there may be limits on the amount of
interest, dividend, and rental income that the S corporation may receive; etc.

If the shareholder does not materially participate in the operation of the S corporation, that shareholder will own a passive activity interest