LLC Partnership: Active vs Passive Partner

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LLC Partnership: Active vs Passive Partner

Postby Go Blue 99 » Fri Mar 01, 2013 12:40 pm

A few months ago, I posted here about amending 3 years' worth of tax returns to include Schedule K-1 losses that we'd previously ignored. The advice here was to work with a CPA due to the complexity involved, so I did that. The CPA is in the process of finalizing the amended returns.

These K-1s are generated by a stake my wife has in her family business. The CPA brought up an interesting point though. Every K-1 she's received has her designated as a General Partner and Active Individual. He says this means she is supposed to have a material participation in the business (100 hours+ per year). This family business is out-of-state and she doesn't meet that hours requirement. The CPA said that the downside of being designated as an Active Partner is that she will have to pay Self-Employment taxes on all gains.

In light of this, should I work with her family & the business's accountant to get her status changed to Passive Partner? Or will this be a problem since all the K-1s to date have her listed as an Active Partner? From what I can tell, the only downside of being a passive partner is that losses can only be offset by passive income.

Are there any other issues I need to consider? Thanks.
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Re: LLC Partnership: Active vs Passive Partner

Postby JoeJohnson » Fri Mar 01, 2013 11:31 pm

Follow what the law says, you don't really pick and choose active vs. passive. Seek professional advice from a CPA.

Edit: Schedule K-1 should list your wife as General Partner or Limited Partner. However, I don't think the K-1 from the business will tell you if you're active or passive. It's up the partner and their CPA to determine active vs. passive and put the income (loss) on the appropriate form. As above, consult a professional. Passive losses are only deductible to offset passive income. The IRS got annoyed many years ago when people were dumping money into losing partnerships for tax shelter, so they created the passive loss rules.

Does your wife get a guaranteed payment from the partnership?

Disclaimer: The above is neither legal nor accounting advice.
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Re: LLC Partnership: Active vs Passive Partner

Postby zzcooper123 » Sat Mar 02, 2013 9:06 am

LLC's don't have General or Limited partners, only members. Now you might have a managing member with slightly more liability. Or a tax member.
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Re: LLC Partnership: Active vs Passive Partner

Postby thepommel » Sat Mar 02, 2013 9:58 am

zzcooper123 wrote:LLC's don't have General or Limited partners, only members. Now you might have a managing member with slightly more liability. Or a tax member.


Correct. From a legal point-of-view, LLCs have members. Managing members are actively involved in the management of the business. Otherwise, the member may hire a professional management.

However, from a tax point-of-view, an LLC can be treated in flexible ways.
Even though the member(s) have the ability to make elections, the IRS applies defaults based on the particular fact pattern.

- A single member LLC is treated by default as a disregarded entity ("disregarded as separate from its owner") for tax purposes- Schedule C.
However, the single member LLC can elect to be treated as a corporation - Form 8832.

- A multiple member LLC is treated by default as a partnership for tax purposes - K-1.
However, the multiple member LLC can elect to be treated as a corporation - Form 8832.

- I understand certain LLCs which elect to be treated as a corporation can make a further election to be treated as an S-Corporation - Form 2553.

It appears the family business referred to by the OP has already chose the partnership or S-Corp taxation path since the business is generating K-1s to the wife. (S-Corporations and partnerships would generate K-1s annually for each pass through owner).

The legal entity form and the taxation treatment are different animals.
In the eyes of the IRS, the legal members of the LLC (in this case) are treated as "partners" (partnership) or "pass through shareholders" (S-Corp.).

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Limited-Liability-Company-%28LLC%29

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Re: LLC Partnership: Active vs Passive Partner

Postby neurosphere » Sat Mar 02, 2013 11:04 am

My case might help to serve as an example of one way things can be set up. My family is involved in a business, which is an LLC. It has two "members". Each of those members is a "partnership", which has both active and passive partners (i.e. general and limited partners). So there are TWO members in the LLC, but 10 total partners (5 in each of the two partnerships which are the two "members").

Can I ask a quick question about income to a limited/passive partner? If losses from the partnership exceed passive gains, what are the rules for carrying those losses forward? How much, if any, can losses be deducted in excess of passive gains within the same year?

I'm off to google the answers, but thought I would annoy sscritic by asking here first. :D

NS
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Re: LLC Partnership: Active vs Passive Partner

Postby JoeJohnson » Sat Mar 02, 2013 11:58 am

neurosphere wrote:Can I ask a quick question about income to a limited/passive partner? If losses from the partnership exceed passive gains, what are the rules for carrying those losses forward? How much, if any, can losses be deducted in excess of passive gains within the same year?

I'm off to google the answers, but thought I would annoy sscritic by asking here first. :D

NS


passive losses carry forward indefinitely. $0 deductible in excess of passive gains i.e. if your only passive activity is a losing partnership, you lose money and never see a tax benefit
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