LLC Material Participation Policy Shift: New Regulations Focus on Management Rights
Journal of Legal Issues and Cases in Business, 2014
21 Pages Posted: 24 Apr 2015
Date Written: September 24, 2014
Until it issued proposed regulations in November 2011, the IRS had treated members of limited liability companies (LLC's) and limited liability partnerships (LLP's) presumptively as limited partners for purposes of the passive loss limitations under an outdated set of Sec. 469 temporary regulations issued in 1988. After losing several significant court cases, the IRS has relented and changed its limited partner test, shifting the focus from limited liability to managerial responsibility. The courts have held that LLC and LLP members should not presumptively be treated as "limited partners" when applying the regulations' material participation tests because state law allows members of these hybrid entities to participate in management. Thus, managing members frequently can meet one of the general material participation tests. While the IRS has taken a first step to resolve the issue, the proposed rules are unclear in some respects, and the new policy will not take effect until the regulations are finalized. The IRS also missed an opportunity to address a related LLC issue, the treatment of LLC members for purposes of the self-employment tax. Still, a significant policy shift has taken place that more accurately reflects the prevailing methods of doing business as a member-managed Limited Liability Company.
Keywords: Passive losses, limited liability company, limited liability partnership, material participation, member, limited partner, general partner
JEL Classification: K34
Suggested Citation: Suggested Citation