LLC Entity Classification Dilemma

[Tax Sleuth]

After the first three months of 2012, a multiple member LLC (husband/wife) taxed as a partnership should have ended because the entity became a single member LLC, just the wife, in accordance with the revision of the LLC's operating agreement. However, the prior accountant filed partnership tax returns for 2012 and 2013 for federal and state, continued to show the husband as the TMP of that partnership, and issued K-1s for both individuals. Presumably, no Form 8832 was ever filed to report the change in entity classification. Now that the owner of the single member LLC, the wife, has become aware of this error, what needs to be done to correct this situation?

[ATSMAN]

2012 tax year is still open for amendments, so go ahead and amend it!

[Tax Sleuth]

1) The partnership returns, federal and state, for 2013 clearly should not have been filed at all. How should this situation be resolved?

2) Furthermore, how should the IRS be notified and informed about the change in the entity status that occurred in 2012 at this late date? Will there be penalties imposed by the IRS because of this misclassification of the entity for 2012 and 2013?

[Burke]

You are correct about the partnership returns. However, from the practical side, will any change result in the final tax situation if it is corrected? You said it was a husband and wife. Did they file a joint return? Did they divorce/separate? Both the LLC and partnership would be pass-through items. If the entity changed in 2012, I am surprised they did not hear at least from the state when the partnership was filed in 2013.

[ChEAr$]

After the first three months of 2012, a multiple member LLC (husband/wife) taxed as a partnership should have ended because the entity became a single member LLC, just the wife, in accordance with the revision of the LLC's operating agreement. However, the prior accountant filed partnership tax returns for 2012 and 2013 for federal and state, continued to show the husband as the TMP of that partnership, and issued K-1s for both individuals. Presumably, no Form 8832 was ever filed to report the change in entity classification. Now that the owner of the single member LLC, the wife, has become aware of this error, what needs to be done to correct this situation?

The prior accountant needs to prepare necessary amendments for free, Unless he didn't know the facts. But he should have asked the questions about any changes instead of just taking the information as dropped off at his office with no interview.

[Tax Sleuth]

If the client wants to confront the prior accountant about past work, then she may do so.

I understand the partnership returns have to be amended for 2012. There is a short partnership year for 2012, and a Schedule C would have to be filed for the remainder of the year.


However, the partnership returns should not have been filed at all in 2013! A Schedule C should have been filed for the single member LLC.


1) Should an amended return be filed for 2013 for the Form 1065 showing all zeroes where numbers used to exist along with a representation letter of explanation about the entity classification change? Does anything else need to be submitted in this situation to the IRS in regards to the entity classification change (i.e. Form 8832)?

2) I do not believe there is going to be any change in regards to the final tax situation once the tax corrections are made. Will there likely be any IRS penalties or fees imposed solely because of the fact that the entity was misclassified in 2012 and 2013?

[Burke]

2) I do not believe there is going to be any change in regards to the final tax situation once the tax corrections are made. Will there likely be any IRS penalties or fees imposed solely because of the fact that the entity was misclassified in 2012 and 2013?

If the corrections result in no change at all in the tax situation of the two partners shown on the 1065 (assuming H&W filing a joint return), I do not see any reason for any penalties or fees by the IRS.

[Matt Sova]

Agree with Burke

From a practical side, if there is no change in total tax due the only difference would be, if there was income, an increase in the wife's SE tax and decrease in the husband's SE tax. I think this is something that should be discussed with the client prior to racking up billable time amending a return that will not result in any real differences.

[Tax Sleuth]

I really appreciate the responses in regards to this matter, and I agree that a conversation with the client has to occur in regards to the fact that there is likely going to be no change in the final tax result. This situation is a bit unusual in my experience.


Does anyone have an answer for my other question? It is once again as follows:

1) Should an amended return be filed for 2013 for the Form 1065 showing all zeroes where numbers used to exist along with a representation letter of explanation about the entity classification change? Does anything else need to be submitted in this situation to the IRS in regards to the entity classification change (i.e. Form 8832)?

[Burke]

I think that would just confuse matters at this point. If there is no change in tax, whether it be SE or other, I would be inclined to let it go until such time as some letter or request for explanation/information arrives.