Academic journal article Journal of Accountancy

Debt Allocation and LLCs

Academic journal article Journal of Accountancy

Debt Allocation and LLCs

Article excerpt

The number of limited liability companies (LLCs) in the United States is increasing dramatically. Most choose to be taxed as partnerships and follow the normal partnership rules. However, some of those regulations must be adjusted as a result of the owners' limited liability. Recently the Tax Court considered the special rules that apply to the allocation of liabilities to LLC members.

Gerald Forsythe owned 70% of In-deck Energy Services Inc. (IE), a C corporation, and owned 100% of In-deck Power Overseas Ltd. (IO), an S corporation. Forsythe and 10 owned IPO II, an LLC; Forsythe owned 1% and IO the remaining 99%. IPO II purchased an airplane funded by a $9.4 million loan from Nationsbanc Leasing Corp. that Forsythe and IE guaranteed. The loan guarantee said neither of them would be entitled to reimbursement for any payments they made under the guarantee. Forsythe included the entire loan in his basis in IPO II since IE wasn't a member of the LLC. The IRS concluded that part of the loan should be allocated to IO under the related-party rules and should be included in IO's basis in IPO II.

Result. For the taxpayer. The Tax Court had to decide how to allocate an LLC's liability. Under the general rule of IRC section 752, a recourse liability is allocated to the partner that bears the economic risk of loss. Normally a loan guarantee would not cause a guarantor to fall into this category because the guarantor would be entitled to reimbursement for any payments made. But in this case the guarantee agreement provided that Forsythe was not entitled to reimbursement and therefore he is treated as bearing the economic risk of loss. Several parties guaranteed the loan but only Forsythe was an owner of the LLC. …

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