TAX &
BUSINESS
LAW REPORT
A Newsletter of the Tax & Corporate Practice Group
Editor’s Note…
With the opening of
our new Philadelphia
office (the 15th Floor
of 8 Penn Center), we
have substantially
expanded our
regional presence.
Moreover, with resi-
Richard J. Flaster dent lawyers based in
Philadelphia having practices in the fields
of employment law, intellectual property
law, environmental law, and general litiga-
tion, we have enhanced our capabilities
and availability to our clients in the
Philadelphia area.
This current Tax and Business Law
Report provides a cross-section of articles
of interest — ranging from federal taxa-
tion of compensatory partnership inter-
ests, expanded scope of New Jersey
income taxation, new payroll tax responsi-
bilities for “disregarded entities”, and
changes in individual income tax return
filing procedures.
If you provide us with your e-mail
address and the e-mail addresses of
colleagues who would be interested in
receiving this Report, we would be
pleased to include that information in
the data bank for this Report. Please
send that information to me at
rick.flaster@flastergreenberg.com.
In This Issue. . .
Disregarded Entities Now
Responsible for Employment
and Excise Taxes........................2
Expanded Scope for Taxing NJ
Source Income ..........................3
Longer Automatic Return
Filing Extension ........................3
Copyright © 2005
FALL 2005
New Proposed Tax Regs Could Change Tax
Treatment of Partnership Interests Given
for Services
BY MICHAEL P. SPIRO
Many emerging growth companies are founded when an indi-
vidual with an idea joins together with an individual with money to
finance that idea, and the two form either a partnership or a limited
liability company. Generally, the individual with the idea will receive
his interest in return for providing services to the new company (a
so-called “compensatory interest”), and the individual with money
will receive his interest in return for capitalizing the company. For
years, the proper tax treatment of the compensatory interest has been litigated — the
question being whether the compensatory interest should be taxed currently as income
to the service provider. While it has long been established that the granting of a “capital
interest” (i.e., an interest in the capital as well as profits of a partnership) is taxable to
the recipient, there has been confusion about the treatment of a mere “profits interest,”
which grants an individual no immediate interest in the company’s existing capital
accounts, but only the right to share in future partnership profits. However, the IRS
has recently published new rules under Internal Revenue Code Section 83 which will
now govern the treatment of compensatory partnership profits interests. IRS Notice
2005-43.
Background — The Current Rule
The current rule applicable to compensatory partnership interests was enunciated in
the Eighth Circuit case of William G. Campbell, 943 F.2d 815 (8th Cir. 1991) and
adopted by the IRS in Revenue Procedure 93-27 (as clarified in Rev. Proc. 2001-43).
In Campbell, the taxpayer received a profits interest in a limited partnership interest in
exchange for performing various future services for the partnership. According to the
Campbell Court, the profits interest was not taxable as it had only speculative value and
could not be appropriately valued for tax purposes. In Rev. Proc. 93-27, the IRS set
forth a position consistent with Campbell that where profits are not “substantially certain
and predictable,” the receipt of a profits interest in a partnership is not a taxable event.
The Proposed New Rule
Proposed Regulation 1.83-3(l) now seeks to eliminate much of the confusion
caused by the distinction between “profits interests” and “capital interests” by removing
the distinction altogether. The IRS now proposes that taxpayers must recognize the
(continued on page 2)
This report is for general use and information, and the content should not be interpreted as rendering legal
advice on any matter. Specific situations may raise additional or different issues and such information should be
coordinated with professional legal advice.
Tax & Business Law Report • Flaster/Greenberg P.C.
 2
New Proposed Tax Regs Could Change Tax
Treatment of Partnership Interests Given
for Services
(CONTINUED FROM PAGE 1)
value of all compensatory partnership interests as taxable
income. The Regulation then establishes a “safe harbor”
pursuant to which the value of a compensatory partnership
interest shall be equal to the “liquidation value of that interest.”
Compare with In Re Hill’s Estate 193 F.2d 724 (2d. Cir. 1954).
Under the safe harbor, the value of a profits interest will neces-
sarily be zero, as the holder of such an interest is not entitled to
any capital upon liquidation. Essentially, this new safe harbor
codifies the pre-existing rule with respect to “profits interests”
and eliminates the taxability of profits interests even where profits
are “substantially certain and predictable.”
The key significance of the safe harbor is that such treatment
must be elected by a partnership in order to be applicable.
Moreover, Notice 2005-43, provides that upon adoption of the
Regulation, Revenue Procedures 93-27 and 2001-43 will
become obsolete. Therefore, if the election under Prop. Reg.
1.83-3(l) is not made, the IRS can tax the grant of a compen-
satory partnership profits interest (after the date of adoption of
the final Regulations). It is therefore crucial to understand the
method for making the safe harbor election under Prop. Reg.
1.83-3(l).
Safe Harbor Election
The safe harbor election requires both a filing by the part-
nership and for certain provisions to be placed in the partner-
ship agreement.
First, the partnership must prepare a document, executed by
the partner who has responsibility for Federal income tax
reporting by the partnership (i.e., the Tax Matters Partner),
stating that the partnership is making this election (on behalf of
the partnership and each of its partners) to have the safe harbor
apply irrevocably as of the stated effective date, and the docu-
ment must be attached to the tax return of the partnership for
that year.
Second, the partnership agreement must contain the follow-
ing provisions:
• The partnership is authorized and directed to elect the safe
harbor; and
• The partnership and each of its partners agrees to comply
with all requirements of the safe harbor with respect to all
partnership interests transferred in connection with the per-
formance of services while the election remains effective. If
the partnership agreement does not contain the required
provisions, each partner in the partnership must sign a sepa-
rate document containing those provisions.
Observation
According to representatives of the IRS, Proposed Regulation
1.83-3(l) is expected to be finalized in June of 2006. ◆
Tax & Business Law Report • Flaster/Greenberg P.C.
Disregarded Entities Now
Responsible for Employment
and Excise Tax Filings
BY RICHARD J. FLASTER
Under existing rules, single-owner
“disregarded entities” (such as single
member LLCs or Qualified Subchapter S
Subsidiaries) were not responsible for
employment tax and excise tax obligations.
Rather, the owners of such entities had
this responsibility.
However, with the announcement of Proposed Regulations
§307.7701-2(c)(2), the IRS seeks to treat the disregarded
entity as the employer and to establish its responsibility for:
• Employment Taxes/Back-Up Withholding: Depositing
FICA, FUTA and income tax withholding with the IRS,
filing 941 returns, and issuing W-2 forms.
• Excise Taxes: Reporting and payment of applicable excise
taxes, registering as a buyer or seller in a transaction subject
to excise taxation and claiming refunds and credits in
such transactions.
Observation: The new employment tax rules will take
effect when the final regulations are issued. The new excise tax
rules will take effect for years beginning after January 1, 2006. ◆
Be our guest for breakfast on
Tuesday, January 24th
Rutgers School of Business - Camden
Quarterly Business Outlook
Featuring CEOs of Southern New Jersey
corporations forecasting their economic
outlook for the region in five sectors:
Economic Overview • Commercial Real Estate
Health Care • Manufacturing
Retail/Consumer Products
Clarion Hotel & Conference Center
Cherry Hill, NJ
Registration and breakfast: 7:45 a.m.
Program: 8:30 a.m. - 9:30 a.m.
Co-sponsored by:
Flaster/Greenberg P.C.
Chamber of Commerce Southern New Jersey
Register by e-mail: firm@flastergreenberg.com
 3

New Jersey Taxes on Automatic Extension for

Company with No In-State Filing 2005 Tax Returns
Physical Presence Increased to Six Months
BY MARKLEY S. RODERICK
BY ALAN H. ZUCKERMAN
The Appellate Division of the Superior
In recently issued regulations, the IRS
Court recently held that Lanco, Inc., a
announced that individuals, partnerships
Delaware corporation with no physical
(including LLCs taxed as partnerships)
presence in New Jersey, is subject to the
and certain trusts and other entities filing
Corporation Business Tax (“CBT”) on
2005 federal income tax returns will be
royalties it receives from a New Jersey retailer.
permitted to obtain an automatic six-
Lanco, Inc. v. Division of Taxation, 379
month extension of the due date for the
N.J.Super. 562 (A.D. 2005) reversing an earlier decision of the
return. Previously, the automatic extension was for only
New Jersey Tax Court, this decision changes the rules of the
three or four months (depending on the type of taxpayer),
game for many out-of-state companies which have previously
then the taxpayer had to file another form to request the
assumed they were constitutionally protected from New Jersey
additional extension up to a total of six months. For individual
tax as long as they maintained no physical presence here.
returns (i.e., Form 1040), individuals now need to file only
Lanco owns certain intellectual property (trademarks, trade Form 4868 to obtain an automatic six-month and no longer
names, and service marks) which it licenses to Lane Bryant, a need to file Form 2688 to obtain the additional two-month
retailer with multiple New Jersey locations and receives royalties extension. For partnerships and LLCs taxed as partnerships
on Lane Bryant’s New Jersey sales. However, Lanco has no (and for certain trusts and other entities), these entities
offices, employees, or property of its own in New Jersey. would now file Form 7004 to obtain the automatic six-
In 2003 the New Jersey Tax Court held that New Jersey month extension, instead of having to file first a Form 8736
could not impose the Corporation Business Tax on the royalties for an initial three-month extension, and would then a Form
received by Lanco. Relying on the decision of the U.S. Supreme 8800 to request the additional three-month extension.
Court in Quill Corp. v. North Dakota, a case that involved the Corporations had, and still do have, the ability to obtain an
imposition of sales and use taxes on catalog sellers, the Tax automatic six-month extension by filing Form 7004.
Court held that there was insufficient “nexus” between Lanco Observations: Caution: As before, the obtaining of an
and New Jersey to satisfy the Commerce Clause of the U.S. extension of time to file a tax return does not extend the due
Constitution. date for payment of the tax. Accordingly, in order to avoid
However, following recent decisions from other states, the penalties and interest, the tax must still be paid by the
Appellate Division held that while a physical presence might be original due date (or, perhaps even earlier if the taxpayer is
required to impose sales and use taxes under Quill, it is not otherwise required to make estimated tax payments or have
required to impose state income taxes. The court appears to have tax withheld throughout the year). ◆
accepted the argument made by the New Jersey Division of
Taxation that the “benefits” obtained by Lanco, including the
existence of the New Jersey legal system and New Jersey’s
educated workforce, established a constitutionally-sufficient Office Locations
“nexus” for the imposition of income tax even in the absence of
a physical presence. 1810 Chapel Avenue West 441 East State Street
Cherry Hill, NJ 08002-4609 Trenton, NJ 08608
Observation: While the opinion of the Appellate Division Tel 856-661-1900 Tel 609-695-4000
clearly provides that New Jersey may impose the CBT on Lanco Fax 856-661-1919 Fax 609-695-5111
and other companies receiving royalties from New Jersey sales, 2900 Fire Road, Suite 102A 190 South Main Road
it does not establish — or even suggest — guidelines for Egg Harbor Twp., NJ 08234 Vineland, NJ 08360
determining under what circumstances New Jersey may not Tel 609-645-1881 Tel 856-691-6200
impose the CBT on out-of-state companies. Consequently, Fax 609-645-9932 Fax 856-696-8150
unless the decision is modified or overturned by a higher 89 Headquarters Plaza North 8 Penn Center
court, prudent taxpayers will assume that all income from 14th Floor, Suite 1472 1628 JFK Boulevard, 15th Fl
New Jersey will be subject to the CBT, without regard to any Morristown, NJ 07960 Philadelphia, PA 19103
constitutional restraint. ◆ Tel 973-605-1799 Tel 215-279-9393
Fax 973-605-1344 Fax 215-279-9394

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TAX & CORPORATE PRACTICE GROUP

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