By: Tamara Pow
Limited Liability Companies (LLCs) are complex entities for tax purposes. Generally, for LLCs choosing to be taxed as a partnership, the taxation of independent members depends on the profits or losses of the entity, and the basis of the LLC Member. Even though the calculation of basis is usually left to the company’s tax accountant, all LLC members, and partners in partnerships, should at least understand the basics of basis .
- What is basis? Basis is generally the amount of the member’s investment in the LLC for tax purposes, and the amount of the basis (as adjusted) is used to figure out any gain or loss on sale, exchange, and certain distributions. Certain things that happen during a member’s ownership of an LLC interest will increase or decrease the basis, resulting in an “adjusted basis.”
- What is the initial basis of an LLC member? The initial basis of an LLC member who acquires an LLC interest in exchange for a contribution is equal to the amount of cash contributed, plus the member’s adjusted basis in any property contributed, plus any gain recognized on the contribution of property to the LLC.
Note: if an LLC member buys their interest with a note, the LLC member usually does not get any initial basis for the amount of the promissory note. The member, however, will get basis when the member makes payments under the note.
- What is the initial basis of an LLC member who buys an LLC interest from another member? If a member buys an interest from another member, the initial basis is the amount paid for the membership interest.
- What if a member got an LLC interest by gift? If someone is gifted a membership interest in an LLC, their initial basis is equal to the adjusted basis in the membership interest of the person who gifted them the interest, plus any gift taxes paid on the gift.
- What if a member received the LLC interest through inheritance? If a member acquired the LLC membership interest through inheritance, their basis is the fair market value of the LLC interest for estate tax purposes.
- What causes the basis in an LLC interest to go up? The main factors that increase the basis in an LLC membership interest are the member’s share of LLC income, additional cash contributed to the LLC by the member, the adjusted basis in additional property contributed to the LLC by the member, and any increase in the member’s share of LLC liabilities.
- What causes the basis in an LLC interest to go down? The main factors that decrease the basis in an LLC membership interest include the member’s share of LLC losses, share of nondeductible LLC expenses, cash distributed to the member from the LLC, the adjusted basis of property the LLC distributes to the member, and any decrease in the member’s share of LLC liabilities.
- How do LLC liabilities affect basis? If your LLC incurs a debt or makes payment on a debt, it has a direct effect on the members’ basis. Any increase in a member’s share of liabilities counts as a contribution by that member to the LLC, increasing the member’s basis. Any decrease in a member’s share of liabilities counts as a distribution by the LLC to that member, decreasing the member’s basis. The member’s share of liabilities depends on whether the debt is a recourse or a nonrecourse liability.
- What is a recourse liability? A recourse liability is a liability where, the member legally bears all or part of the risk of loss. In other words, the member would have to pay the LLC’s liability if the LLC could not.
- What is a nonrecourse liability? A nonrecourse liability is a liability where, the member, does not bear any risk of loss – the creditor would only be able to go after the assets of the LLC for repayment, not the assets of the members.
Understanding the basis in your LLC interest is critical, but it is only the first step in planning for tax consequences of LLC membership. This information is intended to assist you in understanding the conversation with your tax advisor.
Tamara B. Pow worked as a tax consultant at Price Waterhouse, LLP in San Francisco and San Jose prior to practicing law. She is a founding partner of Strategy Law, LLP in downtown San Jose where she practices business and real estate law including formation and representation of LLCs.
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.