IRS guidance shows risks to nonguarantor LLC members.

• Author: Chambers, Valrie
• Position: Limited liability company

As the limited liability company (LLC) form of business continues to proliferate, lending institutions are frequently requiring LLC members to personally guarantee the debts of these entities. The extent that such guarantees affect the amount of losses available to be deducted has been uncertain in the past, but recent IRS guidance clarifies the treatment of both the guarantor and the nonguarantor members. While the guidance generally benefits the guarantor member, it also highlights the potentially unknown effect on at-risk amounts for any members who have not personally guaranteed the debt.

Practitioners looking for guidance in this area previously had to look to regulations written well before the LLC form of entity became available under state law. Those rules focused on general partners versus limited partners and generally did not allow "limited partners" to treat personally guaranteed debt as "at risk" because, under state law, a limited partner has a right to seek reimbursement from the general partner and the partnership if the limited partner is called upon to pay the guarantee (see Sec. 465(b)(4)). However, in the case of an LLC, all members have limited liability for the LLC's debt and generally do not have the ability to seek reimbursement from the LLC or other members.

To provide clarity on this topic, the IRS Office of Chief Counsel issued Legal Advice AM 2014-003 on April 4,2014. The memorandum addresses the tax consequences under Sec. 465 of a member's guaranteeing the debt of an LLC classified as a partnership (or a disregarded entity), the consequences when the debt of the LLC is classified as "qualified nonrecourse financing" under Sec. 465(b)(6)(B), and the consequences to other members of the LLC when a member guarantees qualified nonrecourse debt.

For an LLC member who guarantees an LLC's debts, the memo indicates that the member will be treated similarly to a general partner who had personally assumed the partnership's debt and who had no right of reimbursement from other members (such as the general partners used in the example in Prop. Regs. Sec. 1.465-24(a)(2)(ii)). In that situation, the member is considered to be "at risk" for the LLC debt guaranteed, regardless of whether the member waives any right to subrogation, reimbursement, or indemnification against the LLC, but only to the extent that the member has no reimbursement right from persons other than the LLC, the member is not otherwise protected against...