Background: New forms of business ownership featuring limited liability are growing in popularity. In particular, the LLC setup is advantageous for its owners (called "members"). As with other pass-through entities, like S corporations and partnerships, items of income and loss of an LLC are passed through to the members. There's only one level of tax as opposed to double taxation for C corporations.
However, the IRS has long presumed that the passive activity loss (PAL) rules automatically apply to LLCs. If a business activity is characterized as a passive activity, the loss may only be used to offset income from other passive activities. Therefore, you can't use a PAL to offset income from wages or other highly taxed income. Any excess loss is suspended and is carried forward to future years.
A passive activity is defined as a trade or business in which you do not “materially participate.”
In the new case, a couple's losses from several LLCs and LLPS were disallowed by the IRS. But the Tax Court disagreed with the IRS' presumption. Unlike a limited partner in a limited partnership, LLC and LLP owners do not compromise their limited liability under state law by participating in management. Therefore, the taxpayers should not automatically be treated as passive investors. If they qualify as material participants, they can deduct the losses against other income.
This new decision may have particular significance for many LLC members. Call us at 1-800-878-4051to see if it affects your situation.
Based on the new Tax Court case, some LLC members may be entitled to refunds for prior years. If you have any questions about the potential tax benefits, call 800-878-4051.
