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"PER SE PASSIVE" RULE NOT APPLICABLE TO LLC'S/LLP'S

A continuing area of uncertainty in the law has been the proper classification of a taxpayer's interest in an LLC or LLP under the "passive activity loss" rules of IRC 469.

As you may recall, the passive activity loss rules generally eliminate a taxpayer’s ability to reduce their tax liability by utilizing losses from their passive activities to offset their otherwise taxable business or investment income. While there are various tests to determine whether a taxpayer “materially participates” in an activity so that the activity will not be considered “passive”, there is a “per se passive” rule applicable to limited partnership investments. Under this rule, losses from limited partnership interests are automatically classified as “passive”.

While many tax practitioners anticipated the result, especially since many owners actively participate in businesses conducted in an LLP or LLC, the U.S. Tax Court (P.D.Garnett, 132 TC No. 19) recently resolved any confusion by holding that a taxpayer's interest in either an LLC or LLP is not subject to the "per se passive" rule because the LLC/LLP owner is nor statutorily barred from management, as are limited partners. Accordingly, the passive activity rules application to the taxpayer turned on whether he "materially participated" in the entities. 

Please discuss any questions or comments with respect to the above article with the AVZ professional who works on your account, or otherwise please do not hesitate to contact Jim O’Connor of our Tax Department at 631-434-9500.