Recent Decisions Affect Characterization of LLC or LLP Interest for Tax Purposes
8/21/2009
Taxpayers who own limited partnership and member interests recently prevailed in two court decisions regarding the tax characterization of their investment. In Paul and Alicia Garnett v. Commissioner and James R. Thompson v. U.S.A., the courts ruled that LLC members and LLP partners are not “limited partners” for passive activity loss limitation purposes. The passive activity loss portion of the Internal Revenue Code limits the amount of losses that can be deducted against income, if the losses are created by activities in which you are not an active participant.
Although the Internal Revenue Service argued otherwise, the Courts stated that an owner of an LLC or LLP interest is not presumptively subject to the passive activity loss rules. Rather, both the U.S. Tax Court and the U.S. Court of Federal Claims agreed that LLC members and LLP partners are not barred from establishing material participation to overcome the passive loss limitations under the seven-prong statutory test.
If you materially participate in the management or administration of an entity in which you have an LLP or LLC interest, you should review your tax returns to make sure that any prior year losses have not been limited inappropriately by the passive activity loss rules.
Visit the Tax Section on our web site to learn more. If you would like to discuss this issue further, please contact Tom Dougherty at 612-336-9330 or tdougherty@lommen.com.