Reporting information regarding LLCs' passive activities.

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

Although regulations require that the determination of the passive or nonpassive status of limited liability company (LLC) income or losses be made at the member level, Form 1065, U.S. Return of Partnership Income, requires a preliminary classification by the LLC. When filling in the "Analysis of Net Income (Loss)" on Form 1065, the practitioner is required to allocate LLC income between active individual members and passive individual members. This requires the LLC to make some assumptions about whether each individual member materially participates in its activities.

These assumptions by the LLC can pose significant problems since the individual member's perception of his or her participation in LLC activities may differ from the perception of the other members of the LLC. When there is potential controversy or the LLC wishes to avoid arguments between members, it should obtain a written representation from the member as to his or her participation or should opt to treat the member as passive.

Example 1. Classifying LLC member losses as active or passive: T LLC has five members, each owning a 20% interest and reporting 20% of LLC income or loss. T's principal activity is a rental real estate activity. T is classified as a partnership for federal taxes. A Inc. is a member and does not actively participate in the rental activity. A is a member and actively participates. M is a member, however, the LLC cannot determine whether he actively participates in the rental activities. The other two members, K and J, did not actively participate in the rental real estate activity. During the current year, the LLC reported a $50,000 taxable loss that is allocated among the members based on their percentage ownership in the LLC.

The Analysis of Net Income (Loss) on Form 1065 should classify the loss of all individual members except F as passive. Since T cannot determine whether M actively participated in the rental real estate activity, M must be classified as passive. There is no requirement to classify the corporation's participation. Consequently, T reports $10,000 as losses allocated to individual active members and $30,000 as losses allocated to individual passive members.

General Reporting Requirements

The reporting required of an LLC under the passive loss rules can be as simple as one line item on the member's Schedule K-1 (if the LLC has only one activity) or necessitate the attachment of supplemental schedules to the members' Schedules K-1...