LLCs and the cash method of accounting.

• Author: Baptiste, Philip J.
• Position: Limited liability company - Brief Article

Limited liability companies (LLCs) have received much publicity as an excellent vehicle to operate a family business. However, planners need to be careful of a potential pitfall if nonmanagement members may be allocated operating losses. LLCs will be prohibited from using the cash method of accounting if more than 35% of losses may be allocated to nonactive owners. If not careful, planners trying to shift income to nonactive family members or seeking to avoid self-employment tax may inadvertently cause the LLC to lose its ability to use the cash method.

Sec. 448 prohibits the use of the cash method of accounting by syndicates. Temp. Regs. Sec. 1.448-1T(b)(3) defines a syndicate as "a partnership or other entity (other than a C corporation) if more than 35 percent of the losses of such entity during the taxable year ... are allocated to limited partners or limited entrepreneurs."

However, the Code itself by reference to Sec. 1256(e)(3)(B) defines a syndicate as any partnership or other entity other than a C corporation if more than 35% of the losses are allocable to limited partners or entrepreneurs. The distinction between allocable and allocated is an...