Basis Calculations for Pass-Through Entities: Challenges for Tax - - PowerPoint PPT Presentation

Basis Calculations for Pass-Through Entities: Challenges for Tax Preparers

Tackling Complex Calculation Issues for S Corporations, Partnerships and LLCs

TUESDAY, JANUARY 8, 2013, 1:00-2:50 pm Eastern

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Frank Gariepy, CPA, Partner Meredith Menden, CPA, MBT, Senior Manager

Stock Basis Calculations for Pass-Through Entities

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IRS CIRCULAR 230 NOTICE

Any tax advice expressed in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties imposed on the taxpayer by any governmental taxing authority or

• agency. In addition, if any such tax advice is made

available to any person or party other than the party to whom the advice was originally directed, then such advice, under IRS Circular 230, is to be considered as being delivered to support the promotion or marketing (by a person other than Eide Bailly LLP) of the transaction or matter discussed or

• referenced. Thus, each taxpayer should seek

specific tax advice based on the taxpayer’s particular circumstances from an independent tax advisor.

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S Corporations

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Background

• S Corporation basis is “simple”
• Increases
• Amounts earned
• Amounts contributed
• Decreases
• Amounts deducted
• Amounts distributed
• Cannot go negative

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From the beginning…

• Initial Stock Basis
• Cash paid for shares
• Net Value of Property Contributed to the Corporation

(FMV or NTV depending on transaction)

• Taxable value of shares received for services

provided

• Carried over from shares received as gift
• Stepped-up for shares inherited
• Any combination of the above

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Increases to Stock Basis

• Capital Contributions (property or cash)
• Ordinary Income
• Investment Income
• Gains
• Excess of deductions for depletion

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Decreases to Stock Basis

• Distributions (property or cash)
• Business Deductions
• Non-deductible Expenses
• Contributions
• 179 Deduction
• Losses

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Who Cares?

• Why and when does basis matter
• the company had losses
• the company made distributions
• there was an ownership change in the company.
• Basis is a piggy bank
• Excess distributions are taxable

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Order of Basis Adjustments IRC Sec. 1367(a)

• Order is very important
• First: stock basis is increased for income items
• Second: it is decreased for distributions
• Third: it is decreased for nondeductible, noncapital

expenses

• Fourth: it is decreased for items of loss and deduction
• Note: If Basis is Positive Before Distributions but would

be zeroed out by deduction items, the excess loss is suspended rather than the excess distributions taxable

• Election to Reduce Basis by Loss or Deduction

Items before Nondeductible Expenses [Reg. 1.1367- 1(g)]

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Example – [Reg. 1.1367-1(g)]

• Sophia owns all of the shares of Princess, Inc.,

an S corporation that incorporated and elected S status on January 1, 2012. The corporation uses a September 30 year-end. Sophia's stock basis on January 1 is $500,000

• The corporation passes through a non-

separately stated loss from business activities

• f $550,000 and $10,000 of nondeductible

meals & entertainment

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Example 1 – [Reg. 1.1367-1(g)]

• Under the ordering rules, the $10,000

nondeductible amount reduces basis before it is reduced by items of loss and deduction

Beginning Basis $500,000 Less: Nondeductible M&E ($10,000) Basis before loss $490,000 Less: Loss (limited) ($490,000) Ending Basis $0 Loss Carried Forward ($60,000) Loss Utilized on 1040 ($490,000)

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Example 2 – [Reg. 1.1367-1(g)]

• If election made to reverse the ordering rules,

the $10,000 nondeductible amount reduces basis AFTER it is reduced by items of loss and deduction

Beginning Basis $500,000 Less: Loss (limited) ($500,000) Basis before n/d items $0 Carryforward Nondeductible M&E ($10,000) Loss Carried Forward ($50,000) Loss Utilized on 1040 ($500,000)

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[Reg. 1.1367-1(g)]

• The election to reduce basis by loss or

deduction items before nondeductible expenses results in a higher deductible loss

• The nondeductible item however carries over to

future years and will reduce basis when there is sufficient basis to absorb it

• If the election is not made, the nondeductible

items do not carry over, even if basis is reduced to zero in the current year

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When to Calculate Basis?

• Normally calculated at the end of the

corporation’s taxable year. [Reg. 1.1367-1(d)]

• Exceptions –
• Disposal of entire shareholder interest
• Disposal of substantial interest

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Example Timing Rules

• Sophia owns all of the shares of Princess, Inc.,

an S corporation that incorporated and elected S status on January 1, 2012. The corporation uses a September 30 year-end. Sophia's stock basis on January 1 is $500,000

• The corporation passes through a

nonseparately stated loss from business activities of $550,000. The corporation made no distributions to Sophia during the year. At September 30th Sophia's basis is adjusted to $0 with a $50,000 loss carry over

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Example Timing Rules

• Sophia contributes an additional $50,000 to the

company on October 1, 2012. Can she take the full $550,000 loss on her personal 2012 income tax return

• No - Those increases in basis are considered in

determining basis at the end of the corporation's next fiscal year, the corporate year-end not the shareholder year-end governs

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Per-Share, Per-Day

• Pass-through items are generally allocated per-

share, per-day [IRC Sec. 1377(a)(1)]

• Each item is divided by the number of days in

the tax year, then that amount is allocated equally among the shareholders who held shares on each day – [IRC Sec. 1377(a)(1)]

• Simplified method: the percentage of stock
• wned is multiplied by the percentage of the

year that it is owned – [1120S Instructions]

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Per-Share, Per-Day Example

• The stock of Twins Corporation, a calendar year

S Corporation is held by Leo and Juliet, who each own 50% on January 1

• Leo sells all of his stock to Juliet for $350,000
• n March 31
• The corporation's income for the year ending

December 31 is $400,000

• Leo had basis of $150,000 in his stock at the

beginning of the year

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Per-Share, Per-Day

• Simplified Method, ordinary gain of $400,000
• Leo is allocated $50,000
• Juliet is allocated $350,000

% of Stock x % of the Year = x Pass-through Items Leo 50% x 25% = 12.5% $50,000 0% x 75% = 0% $0 Juliet 50% x 25% = 12.5% $50,000 100% x 75% = 75% $300,000 Total 100% $400,000

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Per-Share, Per-Day

• Leo’s ending basis is $150,000 + $50,000 =

$200,000

• Gain on sale is $350,000 - $200,000 =

$150,000 capital gain

• Overall income:
• Ordinary Gain: $50,000 x 35% = $17,500
• Capital Gain: $150,000 x 15% = $22,500
• Total: $200,000 = $40,000

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Cut-off Method

• Shareholder’s Entire Interest is Disposed
• Requires “specific accounting election” under

[Reg. 1.1377-1(b)(1)]

• Pass-through items are allocated through cut-
• ff date and then again from cut-off date until

the end of the year

• Basis is adjusted at cut-off date
• Distributions adjust basis

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Cut-off Method - Example

• Same facts as previous examples
• The corporation had net income for the year of

$400,000, made up of a loss of $100,000 through March 31 and income of $500,000 for the remainder of the year

• Leo has other income that brings him into the

35% tax bracket

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Cut-off Method - Example

Income Jan 1 – March 31 Income Apr 1 – Dec 31 Total Leo ($50,000) $0 ($50,000) Juliet ($50,000) $500,000 $450,000 Total ($100,000) $500,000 $400,000 Per-share, per-day Specific Accounting Leo $50,000 ($50,000) Juliet $350,000 $450,000

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Cut-off Method - Example

• Leo’s ending basis is $150,000 – $50,000 =

$100,000

• Gain on sale is $350,000 - $100,000 =

$250,000 capital gain

• Overall income:
• Ordinary Loss: ($50,000) = ($17,500)
• Capital Gain: $250,000 = $37,500
• Total: $200,000 = $20,000 tax
• Leo’s tax as compared to per-share per day is

$20,000 less

• Juliet’s tax is $35,000 more

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Cut-off Method

• All affected shareholders must consent (actual

consent kept in taxpayer records)

• If corporate redemption, all shareholders are

affected

• Election impacts pass-through items only
• One tax return is filed
• May require supplemental schedules for basis

calculations

• Attach election statement to return (means decision

can be deferred until tax return is filed)

• The stock sale agreement should address decision

process

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Cut-off Method – Other Options

• Qualifying Disposition of Stock [Reg. 1.1368-

1(g)(2)]

• Shareholder disposes of 20% or more of the

corporation's issued stock in one or more transactions within any 30-day period during the corporation's tax year (sale or redemption)

• Stock equal to or greater than 25% of the

previously outstanding stock is issued to one or more new shareholders within any 30-day period during the corporation's tax year

• All shareholders who held stock must consent
• The first tax year is deemed to end on the date the

threshold is met

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Other Stock Basis Issues

• Corporate Owned Life Insurance
• Basis reduced by premiums to extent attributable to

“pure” life insurance coverage.

• Portion attributable to increase in CSV is capital

expenditure, not a reduction in basis

• Increased by proceeds (tax-exempt income)
• Proceeds do not increase AAA
• Items increasing basis MUST be reported on

shareholder’s income tax return

• Contributions of appreciated property reduce

basis by FMV, not adjusted basis

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Debt Basis

• Shareholder loans provide debt basis
• Losses can reduce debt basis
• Basis reduction is applied at year-end
• Debt basis is restored before stock basis by

corporate income

• Repayment of reduced-basis loan is taxable
• Capital Gain if debt is evidenced by note
• Ordinary Income if no written note
• Investment income

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Debt Basis - Issues

• Partial Payments
• Gain is recognized
• Computed prorata based on the relationship of the

reduction in basis to face value of the loan

• Example
• Corporation makes payment of $75,000 on reduced

basis debt. Income is calculated as follows: $125,000 (face amount) - $100,000 (Basis) $125,000 (face amount) X $75,000 (repayment) = $15,000 Income

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Debt Basis – Requirements

• Must incur a true economic outlay
• Owed by corporation to shareholder
• Loan made directly by shareholder
• Note not required but recommended
• Over $25,000 debt at year-end is treated as if

evidenced by written note

• Guarantee does not create basis (payments

made by shareholder do create basis)

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Debt Basis – Requirements

• Back-to-Back Loans - Background
• A third-party loans fund to shareholder(s), then the
• Shareholders re-loan to S Corporation
• What if not third party but a related company?
• IRS argues no economic outlay
• Hitchins, 103 TC 711 (1994) supports IRS position

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Debt Basis – Requirements

• Prop. Reg. 1.1366-2(a)(2)
• Preference for any bona fide indebtedness to run

directly from the shareholder to the S corporation.

• Back-to-back loan between a shareholder and two

related S corporations is bona fide indebtedness

• Depends upon all the facts and circumstances

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AICPA Proposed Safe Harbor

• 1. The debt is evidenced by a written note with

an unconditional promise by the corporation to pay the shareholder, on demand or on a specified date, a sum certain

• 2. The interest rate specified in the instrument

meets AFR requirements

• 3. Interest payment dates are specified in the

instrument

• 4. The instrument is legally enforceable under

state law (even transferees would have the right to enforce the terms of the note)

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AICPA Proposed Safe Harbor

• 5. The corporation would not be an obligor or

co-obligor on the note issued by the shareholder to the primary lender in a back- to-back situation (a guarantee or pledge of corporate assets would not be considered as making the company an obligor)

• 6. Interest and principal payments are actually

made pursuant to the agreement

• 7. Loans are reported appropriately on tax

returns and year-end financial statements

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Debt Basis Strategies

• Offset capital gain with capital losses
• Use to deduct investment interest
• Debt for Stock Swap
• Charitable contribution

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Summary

• Keep careful basis records from day one
• Basis is the responsibility of the shareholder
• Tax preparers should be prepared
• Save K-1s in permanent file in case of basis

questions in the future

• Carefully plan debt transactions and follow the

plan

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Partnership Basis Calculation

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Your instructor

• Jacob Wilkinson
• Manager
• National Tax
• Washington, DC

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Calculating Basis in Partnership Interest

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Why Do We Need to Know Basis

• Importance
• Transfer of Interest
• Gain calculation
• Step up under section 743
• Nonliquidating distributions
• Gain on distribution
• Liquidating distributions
• Basis of distributed property
• Deductibility of losses under section 704(d)
• Economic Effect under section 704(b)

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Basis in Partnership Interest

• Initial concepts
• Inside Basis
• Basis of partnership assets
• Outside Basis
• Partner’s basis in partnership interest
• Why are they different?
• What is the impact if have a difference?
• Section 743(b) or 734(b) adjustments (optional or

mandatory)

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Basis in Partnership Interest

• Single Basis Concept
• One single basis even though partners can own

multiple classes of stock

• However, this single basis can have separate

holding periods

• IRS Legal Advice – AM2012-001
• Cannot allocate tax items to different interests in

disregarded entity

• Rev Rul 84-53
• Partner has a unitary basis
• Use FMV to determine portion sold
• Liabilities complicate the issue

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Basis in Partnership Interest

• Calculation of Basis
• When do you calculate basis?
• A partner is only required to compute the

basis of his partnership interest when the computation is necessary to determine his tax liability.

• Where there has been a sale or exchange of

all or a part of a partnership interest or a liquidation of a partner's entire interest in a partnership, the adjusted basis of the partner's interest should be determined as of the date of sale or exchange or liquidation Reg section 1.705-1(a)(1)

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Basis in Partnership Interest

• Calculation of Basis
• Ordering Rules under section 705(a)
• Increased by
• 1. Contributions to the partnership and

purchases of partnership interests (section 722 and 742)

• 2. Taxable income of the partnership
• 3. Income of the partnership exempt from tax
• 4. The excess of the deductions for depletion
• ver the basis of the property subject to

depletion

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Basis in Partnership Interest

• Calculation of Basis
• Ordering Rules under section 705(a)
• Decreased by

1. Distributions of the partnership (section 733) a. Money is considered distributed before other property if made simultaneously. b. Basis adjustments for separate distributions are made in chronological order.

• 2. Losses of the partnership
• 3. Depletion
• See Rev Rul 66-84 – comprehensive example of

basis calculation and ordering rules

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Basis in Partnership Interest

• Contribution of property
• Partner receives basis equal to adjusted basis in

partnership property.

• Distribution of property
• Partners basis is decreased by adjusted basis in

partnership property.

• Exceptions to general rules for –
• Disguised sales
• Shifting of liabilities could cause gain recognition
• Liquidating distributions

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Basis in Partnership Interest

• Calculation of Basis
• Alternative rule under section 705(b)
• Partners basis is equal to their proportionate share of

all assets

• When can you apply this rule
• The partner cannot practicably apply the general rule

set forth in section 705(a)

• Reasonable to conclude that the result produced will

not vary substantially from the result obtainable under the general rule

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Basis in Partnership Interest

• A partners basis cannot be reduced below

zero

• Section 704(d) provides that deductions cannot

be taken to the extent they exceed the partner’s basis

• Section 731(a)(1) causes gain recognition on any

cash distributions to the extent they exceed the partner’s basis

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Basis in Partnership Interest

• Partner’s Basis and Partner’s Capital

Account

• The adjusted basis of a partner's interest in a

partnership is determined without regard to any amount shown in the partnership books as the partner's “capital”, “equity”, or similar account.

• Reg. section 1.705-1(a)(1)

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Basis in Partnership Interest

• Partner’s Basis and Partner’s Capital

Account

• Generally, basis will equal the sum of –
• Tax basis capital account, and
• Partner’s share of liabilities.
• Partners can have negative or deficit capital

accounts

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Basis in Partnership Interest

• Treatment of liabilities – Section 752
• Increase in a partner's share of partnership

liabilities are treated as cash contributions by the partner

• Decrease in a partner's share of partnership

liabilities are treated as cash distributions to the partner

• A liability to which property is subject shall, to the

extent of the fair market value of such property, be considered as a liability of the owner of the property.

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Basis in Partnership Interest

• Section 704(b) vs. Tax Basis
• Initial value is fair market value for contributed

property under section 704(b)

• On distribution of property, the value of the

property must be “booked up” to reflect FMV with a corresponding adjustment to partners 704(b) capital accounts

• Book ups can be made when other significant

transactions occur. See Reg. section 1.704- 1(b)(2)(iv)(f)

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Basis in Partnership Interest

• Other issues
• A partner's note evidencing its obligation to make

a future contribution to the partnership has no basis

• Rev. Rul 96-11 – basis adjustment on charitable

contribution of partnership property

• Section 1411 triggered on the difference between

inside and outside basis.

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Francis J. Gariepy, CPA Partner, Eide Bailly National Tax Office Meredith Menden, CPA, MBT, Senior Manager

Partnership and LLC At Risk Basis

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IRS CIRCULAR 230 NOTICE

Any tax advice expressed in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties imposed on the taxpayer by any governmental taxing authority or

• agency. In addition, if any such tax advice is made

available to any person or party other than the party to whom the advice was originally directed, then such advice, under IRS Circular 230, is to be considered as being delivered to support the promotion or marketing (by a person other than Eide Bailly LLP) of the transaction or matter discussed or

• referenced. Thus, each taxpayer should seek

specific tax advice based on the taxpayer’s particular circumstances from an independent tax advisor.

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Subjects to be covered

• At Risk Basis and Tax Basis
• At Risk Basis
• Debt Allocation Issues
• Proposed Reg & Tax Cases Affecting At Risk

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At Risk and Tax Basis

• Book capital accounts for the relative economic rights of

a partner

• Tax basis tracks the individual partner’s after tax

investment in the partnership

• At risk basis reflects the partners economic risk of loss

by use of the liabilities to finance tax basis losses

• Partnership level debt provides tax basis and at risk

basis for partners to deduct losses prior to repayment of the debt or contribution of capital

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At Risk Basis

At Risk Basis – IRC Sec 465

• Partners and LLC members allocated losses are limited to the

capital contributed and amounts they may be obligated to personally repay or has pledged as security for debt

• Recourse and non-recourse debt can provide basis for

deduction of tax losses in excess of capital for tax purposes

• At risk amounts generally do not include non-recourse debts
• Allocation of “at risk” debt amounts
• Complicated rules using a “constructive liquidation”

approach

• Generally recourse debts allocated by loss ratio and non-

recourse debt allocated by profit ratio

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At Risk Basis

• The roll of debt in computing basis
• Debt reflects the economic at risk amounts of a partner’s

interest in a partnership

• Debt supports the allocations and deductions of operating

losses for tax and at risk purposes

• Deficit capital accounts rare without debt
• Entity level debt for tax and at risk basis is a major difference

between partnerships and S Corporations in computing outside basis

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At Risk Basis

Compliance - Form 6198

• Required form if there are current amounts not at risk
• Non-recourse loans used to finance the activity
• Exception for QNR financing
• Cash, property or borrowed amounts protected against losses

with a guarantee or other type stop-loss arrangement

• Loans that would qualify as recourse or QNR except for the

lender being another partner/LLC member or 10% related member (IRC Sec 465(b)(3)(C))

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At Risk Basis

Compliance - Form 6198

• Increases and decreases to at risk amounts
• Amounts similar to tax basis increases and decreases
• FMV of pledged property – property not used in activity used to

borrow amounts provided to activity

• Cash or adjusted basis of contributed property
• Increase in non-recourse debt or a change from recourse debt

to non-recourse debt can cause a decrease

• Change in QNR debt to recourse due to guarantee can be a

significant decrease

• Deficit basis amounts subject to at risk loss recapture

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At Risk Basis – Debt Allocation

• Allocation of Recourse Debt Reg 1.752-2
• Follows a “constructive liquidation” computations in which

assets are valued at zero and sold for the amount of debt.

• The partner bears the economic risk of loss in this test to the

extent he is obligated to pay the creditor or make a contribution to the partnership to satisfy the liability

• In practice this allocation most often follows the loss ratio of the

partner

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At Risk Basis – Debt Allocation

• Allocation of Nonrecourse Debt Reg 1.752-3
• Partnership minimum gain, the excess of a nonrecourse liability
• ver the 704(b) book value
• Partner’s 704(c) gain if property is disposed for the amount of

the associated debt

• Remaining amounts allocated by profit ratio

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At Risk Basis – Debt Allocation

• Partner at risk basis accounting affected by type
• f entity
• General partnership (GP)
• All partners have unlimited liability for all partnership debts

and would be considered as recourse debts and at risk

• Limited partnership (LP)
• The general partner would have unlimited liability but the

limited partners do obtain at risk basis on QNR debt as the associated real property is considered pledged for the debt (IRC Reg. 1.465-27(b)(4))

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At Risk Basis – Debt Allocation

• Partner at risk basis accounting affected by type
• f partner – cont’d
• Limited Liability Company (LLC)
• Generally all debts are non-recourse and members not at

risk with the exception of direct member loans to the LLC. Member guaranteed loans and debt that qualifies as QNR

• Limited Liability Partnership (LLP)
• Partner is not liable for the debts of the LLP. Allocation rules

will be similar to LLC

• Limited Liability Limited Partnership (LLLP)
• Similar debt allocations rules with Limited Partnerships with

the general partner having unlimited liability

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At Risk – Debt Allocation

Contrast with S Corporations

• Debt within S Corps does not provide at risk or tax basis for

deducting losses by the shareholder

• Shareholder direct loans provide basis
• Very limited tax cases of shareholder guaranteed intercompany

debt providing at risk basis for losses

• No QNR debt allocation within an S corporation will provide at

risk basis for loss deduction

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Example – Tax Basis and At Risk

• Basis comparisons with debt allocations

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Example – Tax Basis and At Risk

• Basis comparisons with disproportional debt

allocations

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Debt Allocation Issues

• Multi-Tiered Partnerships
• Reg 1.752-4(a) An upper-tier partnership's share of the liabilities
• f a lower-tier partnership (other than any liability of the lower-

tier partnership that is owed to the upper-tier partnership) is treated as a liability of the upper-tier partnership for purposes of applying section 752 and the regulations thereunder to the partners of the upper-tier partnership

• Pass-through “recourse” debt can change to “non-recourse”

debt on second tier LLC

• Debt Guaranteed by an upper tier LLC does not become

recourse debt to the member

• Debt Allocable to a DE is allocable to the extent of the DE value

per Reg 1.752-2(k) rather than look through to the owner of the DE

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Debt Allocation Issues

• Shifting of “At Risk” Amounts
• Non-recourse debt and QNR can become “recourse” debt to the

guarantor partner/member and shift the related allocations of expenses to the guarantor

• Debt refinancing in which a new guarantor executes a

guarantee can cause a debt shift and recapture of prior at risk losses

• Drafting guarantees by the appropriate members can insure

allocations do not shift to a single guarantor

• Aggregation of activities IRC Sec 465(c)(2)(B)

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Debt Allocation Issues

Debt Guarantees

• Recourse debt

Minimal effect on at risk amounts for a partner since he steps into the shoes of the creditor upon payment and has a right to collect from the partnership or other partners

• Non-recourse debt

Risk of loss can substantially shift to the guarantor, especially if when there is a waiver of subrogation or recourse against the partnership

• De minimus exceptions

Reg 1.752-2(d) states a guarantor with a 10 percent or less interest in the partnership is not considered to bear the economic risk when they guarantee debt

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Proposed Reg and Tax Cases

Proposed Regulations

• Prop Reg 1.465-6(d) states a guarantor does not receive “At

Risk” basis until the taxpayer/guarantor pays on the guarantee and has no right to reimbursement

• Prop. Reg. 1.465-6(d) is the Service’s position per the IRS Audit

Guide on Partnerships

• This is similar to what an S Corp shareholder would face with a

debt guaranteed by a shareholder

• T.D. 9607 12/21/2012 IRS has retroactively removed the

deminimus rule in the partnership Regs of 1.704-1 (those

• wning less than 10%)

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Proposed Reg and Tax Cases

Tax Cases – Government Position

• 1983 Tax Court Decision, (Brand v. Commissioner 81 T.C. 821)

held partners were not at risk for the partnership loans they guaranteed since they were entitled to reimbursement from the primary obligor

• Subsequent cases uphold the shift in at risk amounts to the

guarantor, (Melvin v Commissioner 88 T.C. 63 (1987), looks at who will ultimately be obligated to pay the partnership debt

• bligations if the partnership is unable
• A limited partner or LLC member are not considered at risk for

partnership recourse debt and the existence of a DRO provision may not change this under Sec 465, (Hubert Enterprises T.C. Memo 2008-46, supplementing, 125 T.C. 72 (2005)

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Proposed Reg and Tax Cases

Tax Cases – Guarantee Increases At Risk Basis

Abramson, Edwin D.,et al, (1986) 86 TC 360 Gefen (1986) 87 TC 1471 Bennion, Sam H., (1987) 88 TC 684

• Tax Court permitted increased basis when
• Guarantee is absolute and unconditional
• There is no right of subrogation, reimbursement from the

entity or other owners

• Guarantor bears the ultimate risk of responsibility for the

debt similar to the hypothetical transaction in Reg 1.752-2 where all of the assets are worthless and the payment of the liabilities is determined by who bears the economic risk

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Proposed Reg and Tax Cases

Partnership Law vs. Limited Liability Companies

• State law applicable to partners may be different for LLC

members in the way liabilities are allocated

• LLC liability will generally be non-recourse with the exception of

QNR debt

• S Corp owner or LLC Member guaranteeing debt may have a

legal right under state law for reimbursement upon paying the guaranteed debt….this takes away the “absolute and unconditional” nature of the guarantee

• Check your state law with a knowledgeable attorney and or

consider changes to your operating agreement to take into consideration the effect of a guarantee and will the allocations of income and losses resulting from the shift still represent “substantial economic effect” under IRC 704(d)

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Summary

• Partnership basis follows 4 separate basis

methods (704(b) ->Tax ->At Risk ->Passive)

• Be aware of outside basis compared to inside

basis

• Review debt obligations annually for

guarantees

• Review operating agreements for possible

changes to avoid un-intended allocations

• Check with tax attorneys on your state law for

LLC members

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• Jacob Wilkinson
• 602.760.2612
• Jacob.Wilkinson@mcgladrey.com

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Frank Gariepy, CPA

Partner 303.459.6706 fgariepy@eidebailly.com

Meredith Menden, CPA, MBT

Senior Manager 507.386.6232 mmenden@eidebailly.com

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