LLC Member’s Income Subject to Self-Employment Tax

Tax law had been unclear for years to what extent self-employment tax must apply to income earned by a Limited Liability Company member. Taxpayers and the IRS over the years have taken positions that LLC units are the same as limited partnership interests, general partner interests, or sometimes one and sometimes the other. Congress has not passed any law to clarify the issue. Recently, however, an important Tax Court case, Garnett (132 T.C. No. 19), provided some clarification. Although the case was about the application of the passive activity rules to LLC income, the court’s conclusion on the nature of LLC units impacts self-employment tax. The tax court found that LLC units are not the same as limited partnership interests under federal tax law. In the past some had argued that LLC income is not subject to self-employment tax because LLC interests are the same as limited partnership interests, which are by definition not subject to self-employment tax. In light of this new court case, that argument is no longer valid.

LLC Member Not Limited Partner – Deductions Allowed

The Tax Court again rejected IRS's position that an LLC member must be treated as a “limited partner” under passive activity loss rules. In the Hegarty case, taxpayers were allowed to deduct losses from their limited liability company tax return under a rule generally not applicable to limited partners. This follows similar decisions against the IRS on this issue by both the full tax court, in Garnett (2009), and the Court of Federal Claims, in Thompson (7/20/2009).

LLC to S-Corporation Conversion Clarified

The IRS has issued a new ruling that applies to a Limited Liability Company (LLC) electing to be taxed as an S-corporation. The ruling clarifies that there does not need to be a short tax year as a C-corporation in the middle of the process of converting from a “partnership” (the default tax status of an LLC) to an S-corporation. Avoidance of the accounting and tax burdens of an intervening C-corporation tax year is welcome to all involved.

Real Estate Section 1031 Exchange QI Conversion

Conversion of Qualified Subchapter S-corporation Subsidiaries (QSSS or QSub) serving as real estate tax-deferred Section 1031 exchange Qualified Intermediary (QI) to C-corporations will not cause the corporations to be treated as new or different Section 1031 QI’s. Therefore, S-Corporation subsidiary conversion to C-Corporation will not cause pending real estate tax Section 1031 exchanges to fail. (PLR 200908005).

Longer Net Operating Loss Carry-Backs for Business Tax

The new tax law, the American Recovery and Reinvestment Act of 2009, allows small businesses that incur Net Operating Losses (NOL’s) in 2008 and later years to carry the loss back 2, 3, 4, or 5 years. Previously only a 2-year carry-back was allowed. For businesses that paid taxes in any of these years but incurred a loss in 2008, this carry-back can result in an immediate tax refund. The new rules apply to all small business tax returns, including S-Corporation tax returns, C-Corporation tax returns, Limited Liability Company (LLC) tax returns, partnership tax returns, and sole proprietorship / Schedule C tax returns. The rules also apply to losses from rental real estate.

Section 179 Business Equipment Deduction Increased

The new tax act increased 2009 Section 179 limits to $250,000 deduction for businesses buying less than $800,000 of equipment. Section 179 allows a taxpayer, other than an estate, trust, and certain noncorporate lessors, to deduct the cost of equipment as an expense instead of claiming depreciation over a number of years.

Bonus Depreciation on Automobiles

Under the new stimulus law, the American Recovery and Reinvestment Act of 2009, a business can increase the first-year depreciation deduction by $8,000 of bonus depreciation for new passenger automobiles, light trucks, and vans placed in service in 2009 is. Since depreciation of passenger automobiles is severely limited by the tax law, this is a good opportunity to accelerate deductions. Applies to all business tax returns: corporate tax returns, S-corporation tax returns, partnership & Limited Liability Company / LLC tax returns, and sole proprietor tax returns.

Non-Resident Partners or Shareholders?

S-Corporations, partnerships, and LLC’s: March 16, 2009 is the Franchise Tax Board deadline for first-time filers and remitters of nonwage withholding for nonresidents to apply under the FTB's 2008 Nonresident Withholding Incentive Program and avoid penalties. Can send in past-due 2008 withholding as additional compensation on behalf of the nonresident payee and pay interest by March 16, 2009 and the FTB will waive some failure-to-file penalties and will not audit withholding for tax year 2007 and earlier.