LLC Member Passive or Active

[KC-CPA]

High Income taxpayer (client) works as an executive for corporation A. The corporation A he works for began a start up company (LLC) which would provide a complimentary product to their business (trucking industry).

They set up an LLC with 3 members. Corporation A is managing member at 55%, taxpayer (client-taxpayer) is 25% and the remaining ownership is another individual at 20%. The LLC's president who runs the LLC reports to the executive at corporation A (Client-taxpayer) that owns 25% of the LLC. The taxpayer owning 25% received K-1 and marked the box as a limited partner/LLC member, he says he spends 500 Hours on it, can bind contracts and would be liable for debt for his share.

So, given those facts, and the fact that technically he meets requirements to be active, however, it seems as an individual and owner at 25% it would be passive, his hours spent would be in the capacity of his corporation executive role.

Obviously he has studied the facts a little, however, I do not think I can get him to be active so he can take the loss from an IRS perspective.

Thoughts?

[Snaggletooth]

Self Employment Tax

Sounds like to me he is wanting to avoid self-employment tax on partnership earnings. A "limited" partner must be truly limited, and not be able to influence partnership decisions. Hardly the case here.

Also there may be an attempt to mess around with transfer prices from one entity to the next, and thus regulate taxable profits. Don't know how well that would stand up if it's happening.

[KC-CPA]

LLC Member Passive or Active

Just to clarify, you think that because he can influence the decision of the LLC he is therefore active on an individual basis as well? You do not see a distinguished difference between his corporate role and ownership and his individual role. I believe he has the ability to influence the LLC but from an corporate representation not an individual representation. No issue with Self Employment as he has already maxed out the amount paid for Self Employment.

Yes, if audited there is all kinds of gray based on this structure.

[Roland Slugg]

I'm a little unsure of the facts. The OP says the client is one of three members in the LLC, but then says he's a limited partner. Then it says he would be liable for the LLC's debt. These are contradictory statements. If the taxpayer is a limited partner, he can ONLY meet the "material participation" requirement via the 500-hour test. Whether or not he can do that is the issue. His involvement with the LLC as an investor does not count. The hours must be spent working and/or managing the activity ... i.e. the trucking business. See Code §469(h)2) and Regs §1.469-5T(e)(2).

His ownership of 25% is not a relevant factor in deciding the active versus passive question. "Material participation" is the controlling issue.

I fail to understand the points raised by Snagg above ... S-E tax and transfer pricing. Neither of these was mentioned in the OP, and although they may be valid points, they don't respond to the question asked in the OP.

[KC-CPA]

I will try to clarify some of the facts: The LLC has 3 members, Corporation A 55%, Individual Investor 1 25%, Individual Investor 2 20%. Individual 1 is also the president of Corporation A; the LLC has a officer who is in charge of the LLC and he reports to him the president of corporation A. Based on this the Corporation A's president and Individual Investor 1 are the same person. As president of the corporation individual 1 meets the requirements active, he has 500 hours, the question is, since he does have control from his corporation role, does that same control meet requirements as an individual investor or is the individual investor role only an investor and passive? Can an individual considered active because of his corporation role and influence? or can he be active for the corporation and passive as an individual investor?