Tax Court rejects IRS’s position that member interests in an LLC are limited partnership interests for passive activity rule purposes under IRC §469. Tax Court rejects IRS’s position that member interests in an LLC are limited partnership interests for passive activity rule purposes under IRC §469.Tax partner Ed Kaplan successfully represented the taxpayer against IRS proposed tax assessments in excess of $2,000,000 in Newell v. Commissioner, TC Memo 2010‑23. In adopting Ed’s arguments, the Tax Court rejected the Service’s long‑standing position that member interests in LLCs are to be treated solely as limited partnership interests for purposes of the passive activity rules under IRC § 469. The Court held that, as a managing member of his LLC, Mr. Newell functioned as a general partner and his activity in the LLC should be tested as such. This decision makes it easier for LLC members to satisfy § 469’s “material participation” standards and avoid its restrictions on deducting passive losses. It enabled our client to currently deduct flow‑through losses from two businesses, one operated as an LLC and the other as an S corporation. News Articles February 17, 2010 CCH Federal Tax Day
WK Federal Tax Day – Current, J.1 LLCs Managing Member Materially Participated in Business Loss Deductions Not Limited by PAL Rules Newell TCM Feb 17.pdf
Federal Tax Day – Current, J.1 LLC’s Managing Member Materially Participated in Business; Loss Deductions Not Limited by PAL Rules (Newell, TCM), (Feb. 17, 2010
Married taxpayers properly deducted the husband’s distributive shares of losses from two businesses and were not restricted in their use of the losses by the passive activity loss (PAL) rules. The husband satisfied the material participation test in Temporary Reg. §1.469-5T(a)(4) because his activity with respect to a limited liability company (LLC) business was a significant participation activity for the years at issue and his aggregate participation in all significant participation activities exceeded 500 hours in each year.
The special rule in Code Sec. 469(h)(2) and Temporary Reg. §1.469-5T(e), which bars an interest in a limited partnership held as a limited partner from being treated as an interest in which the taxpayer materially participates, did not apply to the husband’s interest in the LLC that he held as a managing member. Although the LLC was treated as a partnership for federal tax purposes, the husband could not be treated as holding an ownership interest in a limited partnership as a limited partner. The husband fell within the general partner exception of Temporary Reg. §1.469-5T(e)(3)(ii) because the exception was broad enough to cover LLC interests and, as the LLC’s managing member, the husband functioned as a general partner by actively and substantially participating in the LLC’s management and by handling day-to-day operations.
L.E. Newell, TC Memo. 2010-23, Dec. 58,127(M)
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