Case study: determining the LLC's required year.

• Author: Ellentuck, Albert B.
• Position: Limited liability companies

An LLC TAXED AS A C CORPORATION CAN choose any year end as the tax year end (an LLC classified as an S corporation generally must use a calendar year end). If an LLC is classified as a partnership for federal income tax purposes, however, its tax year is governed by Sec. 706(b). Generally, this section provides that the tax year of a partnership must conform to that of its partners or, for an LLC, to that of its members. (A single-member LLC's required tax year is the tax year of the owner unless corporate classification is elected.) However, if certain requirements are met, there are exceptions to this rule. To determine the tax year-end options of an LLC taxed as a partnership, the following steps must be performed in order:

1. Determine the "required year." Even if the LLC's required year is not used as its tax year, several rules and limitations are based on the required year, such as the allowable year end when making an election to use a tax year other than the required year under Sec. 444. Since changes in member status can cause changes in the LLC's required year, the required year must be determined annually.

2. Determine if the LLC can elect a "nonconforming" tax year (i.e., a year other than the required year) under the natural-business-year or business-purpose exceptions (see Rev. Proc. 2002-39).

3. If the natural-business-year or business-purpose exceptions do not apply, determine if the LLC can elect a nonconforming tax year under Sec. 444. As the price for making this election, the LLC may be required to make prepaid tax deposits with the IRS.

An LLC adopts a tax year by filing its first federal income tax return using that tax year. Filing an application for an employer identification number, filing an extension, or making estimated tax payments indicating a particular tax year does not constitute adoption of that year (Regs. Sec. 1.441-l(c)(l)). This item focuses on the required year rules.

The Required Year Rules

The required year is generally the tax year of the members who own, in the aggregate, more than 50% of the interests in the capital and profits of the LLC (Sec. 706(b)). This provision is the "majority interest" rule. If there is no member or combination of members with the same tax year owning more than 50% of profits and capital, the LLC's required year is the tax year of its principal members. Principal members are those owning 5% or more of either profits or capital. This provision is the "principal members"...