At-Risk Rules and LLCs

T he at-risk rules are de-signed to prevent a taxpayer from deducting losses in excess of his economic investment in an activity. Under Sec. 465, a taxpayer's deductible loss prior to applying any passive activity loss rules is generally limited to the amount he is considered to be at-risk. A taxpayer is considered to be at-risk for an activity by taking into account his cash contributions, adjusted basis of property contributed to the activity and amounts borrowed with respect to that activity. Under Sec. 465, the amounts borrowed can be used for an activity in calculating the at-risk amount to the extent that the taxpayer is personally liable for the repayment of such amount or has pledged assets not used in the activity as security for the borrowed amount. The taxpayer is not considered to be at-risk if the amount borrowed comes from a person related to a person who has the interest in the activity. If the lender has an interest in the activity other than as a creditor, or the taxpayer is protected against loss by guarantees, stop-loss agreements or similar arrangements, or the taxpayer is not personally liable for debt repayment, he would not be considered to be at-risk under Sec. 465.

Field Service Advice (CCA) 200025018 addresses the liabilities of the members of a limited liability company (LLC) and the applicability of the at-risk rules. This memorandum addressed two issues. The first was whether a member, who (in his individual capacity) had entered into an agreement to pay an LLC liability, would be considered at-risk for that liability. The second issue was whether each member who had guaranteed an LLC liability would be at-risk for such amounts. In each situation, the FSA assumed that the LLC would be considered a partnership for Federal income tax purposes; thus, the members were similar to limited partners. It was also assumed that, to the extent a member incurred a liability, he incurred a genuine risk of loss and that there was no understanding or implied agreement that the member would be held harmless.

In the first situation, an LLC had two members. A supplier to the LLC commenced a collection action against it to obtain payment of unpaid balances. The corporation agreed to withhold legal action, provided the LLC paid the outstanding balance plus interest under the terms of a stipulation of settlement. One LLC member executed the stipulation on behalf of the LLC in his individual capacity. The FSA stated that a partner who, through a contractual obligation, has ultimate responsibility for the debt is at-risk with respect to such amount. Therefore, the member who executed a stipulation in his individual capacity was at-risk as to the liability.

In the second situation, an LLC had three members. It entered into a lease agreement with an outside source; the terms stated that each member would be jointly and severally liable for the rental obligation, up to a certain dollar amount. Each member executed a personal guarantee for payment of the rent due under the lease agreement to the extent of this amount. The LLC defaulted on the lease. The outside source began legal action to enforce the personal guarantees. Under Sec. 465, a guarantor of a partnership liability is not at-risk to the extent there is a right of reimbursement against any partner. However, because each member had personally guaranteed a liability up to a certain dollar amount, each member would be considered at-risk for such amount (except to the extent a member has a right of reimbursement against the other members).

From Neil P. Goca III, CPA, Staff Ciampino & Co. P.C., Albany, NY