Discussion:LLC passive loss Garnett case

It looks like this is really good news for owners of LLC's that have passive losses, doesn't it?

Before, there was the Gregg case, but now there's another win for the taxpayers.

It seems to turn more on the definition of a Limited Partner.

It's a win for the taxpayers only in removing the presumption of passivity. They still have to show material participation in order to win. Still, a good result for taxpayers.

LLC is formed near the end of the year and generates a loss, which I run into on a regular basis.

Under 469(h)(2), LP limited partnership interests are presumed passive, except as provided in Regs.

Under Reg 1.469-5T(a), there are seven tests, but only Test (1), related to 500 hours, and Tests (5) and (6), related to past years, can be considered with regard to limited partnership interests in LP's.

General partnership interests in LP's can look to all seven tests.

If the entity is an LLC, then the IRS would assert that there are no general partnership interests at all under the rules defining what constitutes a general partnership interest in an LP.

So, that leaves us with a serious problem, because with an entity formed near the end of the year, it's unlikely that the 500 hour test could be met, and of course the tests related to past years would be inapplicable.

This can be a large tax hit, because typically the owners of the new LLC will have earned a bunch of income prior to setting up the LLC.

But, if LLC's are not the same as LP's, then it's very likely one of the other seven tests in Reg 1.469-5T will fit.

Under the Gregg decision, the taxpayer who was an LLC member won, but this was just one decision, and it was in District Court.

The Garnett case is both a second decision in favor of the taxpayer who was an LLC member, but also is in Tax Court rather than District Court.

Does this analysis make sense.

How thrilled am I that Death&Taxes, Riley2 and KatieJ are weighing in on this discussion, any one of whom I would love to be half as smart as!

Is it fair to say that based on these proceedings petitioners' prior planning prevented piss-poor performance for pork-producers putatively precluded from participation in their presumptively passive partnerships? Or is it not fair to say that?

Harry, what is fair to say is that the court said the IRS got it wrong, not the taxpayer.

"Held: Because Ps did not hold their interests in the L.L.P.s or L.L.C.s as “limited partners”, these interests are not subject to the rule of sec. 469(h)(2), I.R.C. Held, further, because Ps’ interests in the tenancies in common are not interests in limited partnerships, these interests also are not subject to the rule of sec. 469(h)(2), I.R.C."

"In doing so, we recognize that petitioners’ status in these entities differs significantly from the status of general partners in State law limited partnerships, but we also recognize that their status differs significantly from that of limited partners in State law limited partnerships. The need to pigeonhole the ownership interests as either general partner interests or limited partner interests arises in the first instance from the fiction of treating an L.L.P. or an L.L.C. as a “limited partnership” under section 1.469-5T(e)(3)(i), Temporary Income Tax Regs., supra. Inasmuch as classifying an L.L.P. or L.L.C. interest as a limited partnership interest entails a departure from conventional concepts of limited partnerships, it similarly entails, we believe, a departure from conventional concepts of general partners and limited partners. In the final analysis, and absent explicit regulatory provision, we conclude that the legislative purposes of the special rule of section 469(h)(2) are more nearly served by treating L.L.P. and L.L.C. members as general partners for this purpose."

It is more clear that the court said that members of a LLC for only the purposes of section 469(h)(2) should be treated as general partners. The court noted that the issue of self-employment taxes was not before it and therefore declined to comment.

Entrepreneurs Win Tax Case Versus IRS Losses on Business Investments Can Be Deducted Against Salary, Other Income; an Appeal?

  By LAURA SAUNDERS

http://online.wsj.com/article/SB124698320557906557.html

http://op.bna.com/dt.nsf/id/egrr-7u6up6/$File/thompson.pdf

The bifurcation of a managerial vs. investment class of membership would have to be documented in the LLC agreement, which could be quite cumbersome, to say the least.

The PPC Limited Liability Companies guidebook is now saying that taking any other position than the proposed regulations will expose the preparers to penalties unless disclosed on the tax return, even with the new substantial authority standard having replaced the more likely than not standard for preparer penalties.

I know we've gone over all of this ad nauseum, but it's still making me nuts!

So I fold.

There have been five cases that have held that for purposes of the passive activity rules, an interest in a limited partnership (LP) is not the same as an interest in a limited liability company (LLC) or a limited liability partnership (LLP). Garnett v. Commissioner, 132 T.C. No. 19 (2009); Newell v. Commissioner, T.C. Memo. 2010-23; Gregg v. United States, 186 F. Supp. 2d 1123 (Dist.Ore. 2000); Thompson v. United States, 87 Fed. Cl. 728 (Ct.Fed.Cls. 2009), Acq. in result only, AOD 2010-02 (Mar. 9, 2010); and Hegarty v. Commissioner, T.C. Summary Op. 2009-153. This means that an interest in an LLC or LLP is not subject to the rule of IRC §469(h)(2) that provides that the interest is per se passive. That does not mean that the interest is automatically nonpassive (your word is "active"). The taxpayer must still meet the material participation requirements before the interest in the activity will be treated as nonpassive.

Assuming that the taxpayer meets the material participation requirements for the interest in the LLC or LLP. There is still absolutely no definitive guidance as to whether the distributive share of income from an LLC or LLP is subject to SE tax.

IRC §1402(a)(13) provides that where a taxpayer is a limited partner in a partnership, the taxpayer’s distributive share of income or loss of that partnership is not included in SE income. In January 1997, the IRS issued proposed regulations (REG-209824-96) to address the circumstances under which an individual won’t be treated as a limited partner for purposes of SE tax. Prop. Reg. §1.1402(a)-2(h)(2) provides that an individual won’t be treated as a limited partner (and will be subject to SE tax) if (1) the individual is personally liable for debts of the partnership, (2) the individual has authority to contract on behalf of the partnership, or (3) the individual participates in the partnership’s business for more than 500 hours during the year. Despite having been proposed more than 11 years ago, these regulations have not been finalized. While it is true that proposed regulations may be relied upon as a type of authority in determining whether there is substantial authority for the position taken on a return (Treas. Reg. §1.6662-4(d)(3)(iii)), proposed regulations have no legal force or effect until they become final. See Tedori v. United States, 211 F.3d 488, 492 (9th Cir. 2000); Estate of Howard v. Commissioner, 910 F.2d 633, 637 (9th Cir. 1990).

Since the courts have held, for purposes of IRC §469(h)(2), that an interest in an LLC or LLP is not an interest in a limited partnership, it is likely that the exclusion for SE tax purposes that applies to a limited partnership interest in an LP doesn't apply to an interest in an LLC or LLP.

But the IRS is struggling with the SE tax issue right now. According to CCH, on 3/10/2010, at a tax management luncheon for practitioners sponsored by the law firm of Buchanan Ingersoll & Rooney, PC, in Washington, D.C, Diana Miosi, who is Special Counsel for the Office of Associate Chief Counsel (Passthroughs and Special Industries), predicted that guidance on the SE question would be issued in the coming months. I haven't seen any such guidance.

Most tax preparers will treat the distributive share of LLC income as SE income if the member is a managing member of the LLC, but won’t treat it as SE income if the member is not a manager. That seems to make as much sense as the test laid out in the proposed regulations.

Perhaps I folded too quickly. Ctrl-Z then (Undo), and Kevin, here's my quarter. I'm still playing.

*This is an expiring link; to find the document go to legalbitstream.com and search PLRs for that number.

"SEC. 935. MORATORIUM ON CERTAIN REGULATIONS. No temporary or final regulation with respect to the definition of a limited partner under section 1402(a)(13) of the Internal Revenue Code of 1986 may be issued or made effective before July 1, 1998."

The moratorium expired 12 years ago, so why should this preclude the IRS from addressing this issue?

Any other conclusion by the Court would stand common sense on its head.

Too bad the partners didn't make reasonable guaranteed payments subject to SE tax & then argue about the remaining distributive share.