Sec 179 - LLC member

[natiro]

Let's say that we agree that the distributive share of LLC income is not subject to self employment tax solely because the code and regs do not yet specifically require LLC members to pay SE tax on distributive share. Would LLC member be able to use Sec 179 against distributive share?

In the proposed regs, there is an option to split the interests into more than one class of interest. So an LLC member would be able to have an active interest and a limited interest. Let's assume that we will report accordingly. Now the LLC member has 90% limited interest and 10% active interest for distributive share. 100% of guaranteed payments and the 10% active share would be subject to SE tax. If we do this, would the Sec 179 expense be disallowed for the limited interest?

I would expect that the limited interest would not be able to take Sec 179. When I've had passive S-Corp shareholders, Sec 179 is not allowed. However, Lacerte is allowing Sec 179 in this case even though I haven't checked the box to say this is not a passive activity. Am I just missing something obvious? Should Sec 179 be allowed? Would there be any difference in the two situations above?

Thank you!

[Bees Knees]

The LLC as well as an S corporation is allowed to take Section 179, even though the profits passed through to the LLC member, or the S corporation shareholder are not subject to SE tax.

However, if the LLC member or the S corporation shareholder wants to take Section 179 on a different activity that does not have enough profits to justify the Section 179, such as the case were there might be another Schedule C business with no profits, then the individual LLC member of S corporation shareholder cannot use the line 1, K-1 profits to take Section 179.

[natiro]

Thanks Bees, however. . .

I'm not arguing because I do want to take Sec 179 in this situation, but I'm confused by the Code. If we're saying the LLC member is a limited partner for SE tax puposes, can he still be an active member for Sec 179? I believe it is different than an S-Corp because in an S-Corp you're not using the limited partner argument to justify why there is no self employment tax. Here we're relying on classifying the LLC member as a limited partner to which no SE tax applies. IRC 469, below relates to passive activities and so maybe the definition they're using doesn't apply here but I'm very interested to hear your thoughts (or anyone else who wants to chime in!) about this.

IRC 179:

"(A) In general. The amount allowed as a deduction under subsection (a) for any taxable year (determined after the application of paragraphs (1) and (2) ) shall not exceed the aggregate amount of taxable income of the taxpayer for such taxable year which is derived from the active conduct by the taxpayer of any trade or business during such taxable year."

And IRC 469(i)(6)(c) says:

(C) Interest as a limited partner. Except as provided in regulations, no interest as a limited partner in a limited partnership shall be treated as an interest with respect to which the taxpayer actively participates.

Clearly in my case, the taxpayer actively participates so that is not an issue. It's just that limited partner definition that I find so pesky!

[Bees Knees]

Well, using Code Section 469, you could say if you don't pay SE tax on an LLC member's distributive share of profits (because you make the argument that the LLC member is a limited partner), then any loss from an LLC would be subject to the passive activity loss limitations. But I don't think anyone is saying that.

The reason Code Section 469 says a limited partner's interest in a limited partnership is subject to the passive loss limitation rules is because generally, a limited partner could not be an active member in a partnership, except for guaranteed payments. State limited partnership rules generally required that the partner invest in the partnership as an investor, and that the partner could not actively conduct business, otherwise the partner could be considered a general partner, subject to partnership liabilities.

You can't make that argument with an LLC since state law specifically is written to give the active members limited liability status. Section 469 is concerned with active vs. passive participation rules, not SE tax issues.

[natiro]

Thank you!

Thanks Bees. Sounds like a good argument to me. I appreciate your time and thoughtful answers.