Tax Court again ruled against the IRS on LLC losses

[kcjenkins]

LLC Law Monitor My link

Posted at 4:36 PM on March 8, 2010 by Doug Batey

The IRS Again Loses in Attempt to Limit the Deductibility of LLC Losses

The Tax Court has again ruled against the Internal Revenue Service in a case on the deductibility of a member’s LLC losses. Newell v. Commissioner, T.C.M. 2010-23 (Feb. 16, 2010). Last year I wrote about the three prior cases, here My link .

In these cases the IRS has taken the position that its regulations require a presumption that LLC losses are “passive activity losses” (passive losses). Under the regulations this presumption is difficult to overturn, so in many cases LLC losses are treated as passive losses. And for most taxpayers, passive losses are far less useful than active losses (losses not resulting from passive activities). Taxpayers generally prefer to use losses to offset taxable income, but passive losses can only be used to offset income from other passive activities, and not against income such as wages, interest, and dividends.

The Tax Court ruling in Newell is consistent with the prior cases in its interpretation of the IRS’s regulations. The regulations create a presumption that losses incurred by a limited partner in a limited partnership are passive losses, and make it difficult to overcome the presumption. The IRS has taken the position that a member of an LLC should be treated like a limited partner of a limited partnership for purposes of the regulation. The courts, including the Tax Court last month in Newell, have rejected the IRS’s argument.

This latest case should give additional comfort to LLC members, that they should be able to use LLC losses to offset “active” income such as wages. LLC members will still need to demonstrate that they materially participate in the LLC’s management, but they will be able to use the more flexible rules of the IRS’s regulations, without the need to overcome the presumption against material participation.

The IRS could of course change these regulations to explicitly treat LLCs in the same way that limited partnerships are treated. Because LLCs are relatively new, the IRS may still be trying to figure out how to deal with them while limiting the potential for abuse.

[Terry D EA]

This is good to know information and I am going to save the post. Thanks KC

[jainen]

>>give additional comfort to LLC members<<

I'm not convinced that the IRS is altogether uncomfortable about this. In forcing the issue into court, they don't have to deal with Congress when they decide, for example, that LLC's are deemed to have a reasonable wage or SE income. Meanwhile, plaintiffs' attorneys are looking for additional holes in the shield of limited liability, and material participation has a nice sound to it.