K-1 Passive or not

[grandmabee]

I have a 4 person llc files as 1065. 2 husband and wife. both women work in business and take guarantee payments.

husbands will do odd repairs etc around business not much. I know both women are active individual. but the men are they passive. all are 25% partners. I am thinking they don't material participate in the business with the 500 hrs

so if loss then theirs would be passive and carry until the 1065 has gain. and when there is a profit 2 will be subj to SE and 2 will not.

Am I thinking along the right track? I of course would like to have his K-1 offset some of hers but they don't work it.

thanks

[kcjenkins]

We have to go with what we know, and if you know that they are passive members, then that is what you have. But I'd look carefully into it, because usually all LLC members are assumed to be active unless they don't participate at all.

The TaxProf blog had a good piece on this:

Passive Losses and LLCs/LLPs

Jonathan W. Thomas (J.D. 2011, Ohio State) has published Note, Garnett and Thompson: LLC and LLP Losses No Longer Passive Per Se, 5 Entrepren. Bus. L.J. 421 (2010).

Here is part of the Conclusion:

Just like in § 469 and the applicable Treasury Regulations related to material participation, the term “limited partner” is not defined in § 1402(a)(13). Nevertheless, taxpayers who argue that they should be treated as “general partners” rather than “limited partners” for § 469 and passive activity loss purposes, will have to set forth a seemingly contradictory argument that they should be considered “limited partners” and not “general partners” for § 1402 and self-employment tax purposes. The Tax Court’s detailed reasoning in Garnett that members of LLCs and partners of LLPs are more akin to “general partners” than “limited partners,” combined with the Court of Federal Claim’s holding in Thompson that such members and partners are not subject to the “limited partner” restriction of § 469(h)(2), will make taxpayers’ potential contradictory arguments, for § 469(h)(2) passive activity loss purposes and § 1402 self-employment tax purposes, even more difficult.

[grandmabee]

I was looking at the 500 hours to materialy participation.

[joe]

be careful here. sometime the IRS can argue that if one is active, it automatically makes the spouse active as well

[grandmabee]

be careful here. sometime the IRS can argue that if one is active, it automatically makes the spouse active as well

i would like the spouse active. but I just want to do it the correct way.

[mcb39]

KC???? Had a client come in yesterday with three K-1s Form 1065. She is checked General Partner and I know that she is active and participates. All three are losses. The Box 1, Ordinary Income box is filled in with the loss. However, loss is not carried down to Box 14 SE Earnings loss. She is a 50% partner on two of these and a 10% on one. My question is whether these losses can be taken to offset her taxable SE income as a Schedule C Insurance Agent. She says that the accountant doesn't know that she has another business as she is my client and the Partnerships were handled by her Partner's accountant. He doesn't return my calls. If I let the losses go to the SE, will the IRS disallow them because he didn't put them in Box 14?

[jainen]

>>loss is not carried down to Box 14 SE Earnings loss<<

Perhaps she did not have an SE earnings loss. Box 14 should not necessarily be the same as Box 1. It's a bit unreasonable to expect the accountant to set aside his other business right before April 15. Put your client on extension until you have time to get your explanations.

[kcjenkins]

Generally, if she is a 'general partner' and active in the business the gains and losses would be considered SE income or loss. Does the other accountant have an email address on anything he sent her? If so, perhaps you can get an answer that way? I know I get to hating the phone this time of year, but during coffee breaks I do read email, and this site, of course.

You might need to extend her, if you can not get answers, assuming the amounts are significant. You do not want to guess, because it is not always true that box 1 and box 14 are the same.

[jainen]

>>the gains and losses would be considered SE income or loss<<

That's certainly true, but it doesn't mean Box 1 and 14 should be the same. For example, Section 179 is a common deduction that must be stated separately.

Assuming the K-1s were issued timely, it's not fair to wait until now to ask accounting questions. Have the partnerships even signed authorization for release of information? How would YOU respond if a client phoned today and said some other tax guy is questioning your work?

[kcjenkins]

I was looking at the 500 hours to materialy participation.

Material Participation

A trade or business activity is not a passive activity if the taxpayer materially participates in the activity. One materially participates in a trade or business activity for a tax year by satisfying one of the following tests.

The taxpayer participates for more than 500 hours during the taxable year. In counting hours of participation, spouses' hours are added together. An individual's participation in an activity may be established by any reasonable means. Time reports and logs are not required. Treas. Reg. section 1.469-5T(f)(4).

The taxpayer's participation is substantially all of the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.

The taxpayer participated in the activity for more than 100 hours during the tax year, and he/she participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year.

The activity is a Significant Participation Activity, (SPA) and the taxpayer's aggregate participation in all SPA's for the taxable year exceeds 500 hours. A significant participation activity is any trade or business activity in which the taxpayer participated for more than 100 hours during the year and in which the taxpayer did not materially participate under any of the material participation tests, other than this test.

The taxpayer materially participated in the activity for any 5 (whether or not consecutive) of the 10 preceding years. When determining whether the taxpayer materially participated in tax years beginning before 1987 (other than a tax year of a partnership, S-Corporation, estate, or trust ending after 1986), the taxpayer materially participated only if he/she participated for more than 500 hours during the tax year.

The activity is a personal service activity in which the taxpayer materially participated for any 3 (whether or not consecutive) preceding tax years. To determine material participation in tax years beginning before 1987 (other than a tax year of a partnership, S-Corporation, estate, or trust ending after 1986), the taxpayer materially participated only if he/she participated for more than 500 hours during the tax year.

For the passive activity rules, a corporation is a personal service corporation if it meets all of the following requirements.

It is a corporation (other than an S-Corporation).

Its principal activity during the "testing period" is performing personal services. The testing period for any tax year is the previous tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of:

the last day of its tax year, or

the last day of the calendar year in which its tax year begins.

The services in (2) must be substantially performed by employee-owners. This is met if more than 20 percent of the corporation's compensation cost for its activities of performing personal services during the tax year are for services performed by employee-owners, and

Its employee-owners own more than 10 percent of the fair market value of its outstanding stock on the last day of the testing period.

Personal services are those performed in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.

A person is an employee-owner of a personal service corporation if both of the following apply.

He or she is an employee, or performs personal services for or on behalf of the corporation as an independent contractor, during any day of the testing period, and

He or she owns directly or indirectly any stock in the corporation at any time during the testing period.

The taxpayer's participation is regular, continuous, and substantial. The participation must be more than 100 hours per year and then it is a facts and circumstances determination. Treas. Reg. section 1.469-4((1) defines trade or business activities as:

* * * activities, other than rental activities [as defined in Treas. Reg. section 1.469-1T(e)(3)] or activities that are treated under Treas. Reg. section 1.469-1T(e)(3)(vi)( as incidental to an activity of holding property for investment, that-

Involve the conduct of a trade or business (within the meaning of [iRC] section 162);

Are conducted in anticipation of the commencement of a trade or business; or

Involve research or experimental expenditures that are deductible under [iRC] section 174 (or would be deductible if the taxpayer adopted the method described in [iRC] section 174(a)).

[mcb39]

>>the gains and losses would be considered SE income or loss<<

That's certainly true, but it doesn't mean Box 1 and 14 should be the same. For example, Section 179 is a common deduction that must be stated separately.

Assuming the K-1s were issued timely, it's not fair to wait until now to ask accounting questions. Have the partnerships even signed authorization for release of information? How would YOU respond if a client phoned today and said some other tax guy is questioning your work?

It sure wouldn't bother me because I do some Partnership returns for clients who then take their K-1s to another accountant for various personal and ethical reasons. I know that the K1s she received are pertinent to SE Income as she is a 50% General and Active Partner. Please don't mess with my brain so late in the game. I think that I asked a reasonable question. (She just got the K-1s yesterday and came immediately to my office with them. I have been doing her taxes for years and she trusts me.) She has two separate things going on. Her old insurance business and her new Partnership with new boyfriend business. She invested all of her money therein and it is not my place to question her sanity for doing that. There is nothing in box 12 for Section 179. The only other box that has an entry is 13 with $250 for donations.

[jainen]

>>I asked a reasonable question<<

You might well be guessing right that the K-1s are in error, but you can't support that conclusion with what you posted here. If the CPA returned your call, what exactly would you ask? Do you want him to recalculate the return because you don't understand it? Do you want him to tell you what his instructions from the partners were?

There isn't time for that right now. Either use the K-1s as printed and consider amending later, or go on extension until later.

[michaelmars]

the problem also arises if the business doesn't require 500 to operate, does that mean the client avoids se tax on lets say the collection of commissions for a business that was generated in a prior year?

[mcb39]

>>I asked a reasonable question<<

You might well be guessing right that the K-1s are in error, but you can't support that conclusion with what you posted here. If the CPA returned your call, what exactly would you ask? Do you want him to recalculate the return because you don't understand it? Do you want him to tell you what his instructions from the partners were?

There isn't time for that right now. Either use the K-1s as printed and consider amending later, or go on extension until later.

FYI......Accountant just faxed over the corrected K-1s for my client showing the SE losses in Box 14. Just goes to show "Don't believe everything you read!" and/or "When in doubt, ASK!"