Gary Bode, CPA: if you'd like a free consultation with a small business accountant who keeps up with IRS trends, please consider calling us at (910) 399-2705.
IRS Regulations are constantly challenged. Sometimes fortune favors the bold, if you stay current on tax issues. Currently, LLC Members are considered to be “limited partners” with respect to passive activity losses in the IRS Regulations. But five recent tax court cases ruled that LLC Members are “general partners” for these same purposes.
“Despite the more restrictive IRS Regulations, recent tax court cases make it easier for LLC Members to write off passive activity losses.”
Gary Bode CPA, Small Business Accountant
How it Works
The IRS doesn’t make it easy to write off passive losses. Generally, you have to materially participate in the underling business activities. Limited partners can only use three of the seven material participation IRS tests, listed below; specifically the first, fifth, and sixth. Making it unlikely they’ll qualify to deduct passive activity losses, unless they have passive gains to offset. If you just follow the IRS regulations.
We’re never anxious to tread into tax court. Maybe other strategies exist, like obtaining a Private Letter Ruling. But before passing up signifigant passive activity loss deductions, it pays to review the five recent tax court cases. Would you qualify for the loss deduction if you can use all seven of the material participation tests? If so, how much real cash is generated by the reduced tax liability? Remember tax savings are (generally) the deduction times your marginal tax rate. How would you react if a tax audit forced you into tax court?
If you’d like a free initial consult with a Wilmington NC CPA Firm who stays current on tax trends, please consider calling us at (910) 399-2705.
Here’s the seven IRS material participation tests:
1. More-Than-500-Hours Test
This test is passed if the taxpayer participates in the activity for more than 500 hours during the year.
2. Substantially All Test
This test is passed if the taxpayer’s participation in the activity during the year constitutes substantially all the participation by all individuals (including those who are not owners of interests in the activity) during that year.
3. More-Than-100-Hours Test
This test is passed if the taxpayer participates in the activity for more than 100 hours during the year, and no other individual participates more than the taxpayer during that year.
4. Significant Participation Activity (SPA) Test
This test is passed if the activity is a SPA (a weird term of art that is defined in Temp. Reg. 1.469-5T) in which the taxpayer participates for more than 100 hours during the year, and the taxpayer’s total participation in all SPAs during the year exceeds 500 hours.
5. Prior-Year Material Participation Test
This test is passed for the year if the taxpayer materially participated in the activity for any five of the ten immediately preceding years.
6. Personal Service Activity Test
This test is passed for the year if the activity is a personal service activity, and the taxpayer materially participated in the activity for any three preceding years.
7. Facts and Circumstances Test
This test is passed if consideration of relevant facts and circumstances dictate that the taxpayer materially participated in the activity on a regular, continuous, and substantial basis.
Small business accounting isn’t just about tax preparation. As a small business CPA, I feel accurate tax preparation is only the first step. Proactive tax positioning to reduce future tax liability is important too. Watching out for red flags helps prevent tax audits. Tax refunds are great, but correct estimated tax payments keep you from over paying the IRS in the first place. Guarding the “back door” of the business by keeping an eye on sensitive accounting functions, like payroll processing, helps deter embezzlement. QuickBooks training assures accurate and timely bookkeeping. Powerful managerial tools can be built from your small business accounting data, like the ones Fortune 500 companies use.
We’re a Wilmington NC small business accounting firm. If you’d like a free initial consultation with a CPA on any LLC issue, please consider calling us at (910) 399-2705.
