By: Tamara Pow
In my last blog I discussed the tax considerations members of a limited liability company (“LLC”) may face when they make contributions to an LLC that is taxed as a partnership. This blog explores the tax consequences for members making contributions to LLCs that are taxed as corporations. For a limited liability company (“LLC”) taxed as a corporation, the general rule is that members do not recognize any tax gain or loss on their contributions of cash or property to the LLC in exchange for a membership interest so long as the contributing members end up owning at least 80% of the LLC membership interests after the contribution (IRC Section 351).
Contribution of Property
However, if a member contributes property with liabilities and the LLC assumes the liabilities, the member will have taxable income to the extent she is relieved of those liabilities and the amount of the liabilities exceeds her tax basis in her LLC interest. This tax result may be avoided by having the member contribute a valid and unconditional promissory note to the LLC that does not exceed the basis of the assets transferred to the company. This solution is not available to LLCs taxed as partnerships.
Contribution of Services
If a member contributes services to an LLC taxed as a corporation, the member will recognize ordinary income equal to the value of the LLC membership interest received in exchange for the services, unless the interest is not freely transferable and is subject to a substantial risk of forfeiture. A member contributing services to an LLC taxed as a corporation should get the advice of a good tax accountant to determine whether the membership interest is immediately taxable and if such treatment can be avoided or reduced by the filing of a Section 83(b) election.
Contribution of Cash
If all the members are contributing cash to an LLC, taxes on contributions are not a concern. Likewise, if all the members are contributing property to the LLC free and clear of liabilities, and will collectively own 80% or more of the LLC after the contributions, taxes on contributions are not a concern.
However, if members are contributing services, or properties subject to liabilities, be sure to check with your tax advisor prior to finalizing the structure and language of your operating agreement.
Tamara B. Pow is a founding partner at Strategy Law, LLP in downtown San Jose, California. She has been practicing LLC, partnership and real estate law in California for 20 years. As an LLC attorney with an MBA, a California real estate broker’s license and experience in public accounting, I cannot overemphasize the importance of tax planning and consulting with a lawyer or CPA who is knowledgeable about member contributions to LLCs before the contribution is made.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.