“To combat tax shelters in the 1980s, Congress passed a rule preventing taxpayers, who held an interest in a limited partnership, from offsetting any losses from the limited partnership against unrelated, active income from other endeavors,” explained Los Angeles Tax Attorney Bruce Givner who handles tax planning and tax litigation in Los Angeles County. When taxpayers began to use the losses from LLCs (limited liability company) to offset active income, the IRS challenged the offset using IRC Section 469(h)(2). The IRS lost. “In 2011, the Department of Treasury then instituted new regulations for LLC Members and passive activity losses,” noted Givner.
If an entity is classified as a partnership for Federal income tax purposes (See Reg. §301.7701-3), then an interest in that entity is usually considered passive. Passive losses cannot be offset against active income. However, if the holder of the interest has the right to manage the entity, the holder of the interest will be deemed to materially participate in the partnership and partnership losses can then be offset against active income.
A business entity that is not otherwise considered a “corporation” under the applicable standards can elect its own classification for federal tax purposes. If the business entity has two or more members it can choose to be classified as a corporation or partnership. If the business entity has one member, it can choose to be classified as a corporation or a “disregarded entity.” IRS Form 8832 is used to elect a classification. If a business entity with two or more members does not elect a classification, it will be treated as a partnership.
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Givner & Kaye focuses on tax planning and asset protection plans in Beverly Hills, Calabasas, West Los Angeles, Hollywood, and other areas of Los Angeles County. On the first and third Thursday of every month, Givner & Kaye hosts its MCLE & CE accredited series - "Thursday Insights." If you have questions regarding passive losses, call Los Angeles Tax Attorneys Givner & Kaye at (310) 207-8008 today.