¶ 4001
Overview
Scope of the chapter. This chapter opens Part VIII, which examines the federal income taxation of LLCs and their members. An LLC with two or more members that does not elect to be classified as a corporation is a partnership for federal tax purposes, and the great majority of multi-member LLCs are taxed under subchapter K of the Internal Revenue Code. This chapter and the next examine subchapter K as it applies to LLCs. This chapter covers the formation of the LLC and the contribution of property to it, the computation of each member's basis in its interest and of the LLC's basis in its assets, the treatment of LLC liabilities, the limitations on a member's use of LLC losses, and the rules that govern how the LLC's income, gain, loss and deduction are divided among the members. Chapter 41 covers distributions, transfers of interests, the optional basis adjustments and liquidation.
Why the subject belongs in an LLC treatise. The tax rules examined here are not specific to LLCs. They apply to every entity classified as a partnership, including general partnerships, limited partnerships and limited liability partnerships. They are treated here at length for three reasons. First, the operating agreement of a multi-member LLC is in large part a tax document. Its capital account, allocation and distribution provisions are drafted to satisfy the regulations under section 704(b), and a lawyer who drafts or litigates those provisions without an understanding of the regulations will misread them. Second, several of the rules turn on features that distinguish LLCs from partnerships under state law, and the outcome for an LLC member can differ from the outcome for a general or limited partner. The most important example is the treatment of LLC debt under section 752: because no member of an LLC is liable for its debts by reason of membership, LLC debt is ordinarily nonrecourse for tax purposes unless a member guarantees it, and that classification controls how the debt is shared. The passive activity rules supply a second example. Third, the business-law chapters of this treatise repeatedly refer to tax consequences, and this chapter supplies the analysis to which they refer.
Relation to other chapters. The classification of an LLC as a partnership, a disregarded entity or a corporation is examined supra ch. 39. Capital accounts as a matter of business law and drafting are examined supra ch. 13, and the drafting of allocation and distribution provisions supra ch. 14. Profits interests issued for services are examined supra ch. 15, and preferred interests and waterfalls supra ch. 16. Distributions, transfers and liquidation are examined infra ch. 41, single-member LLCs infra ch. 42, the S corporation election infra ch. 43, the centralized partnership audit regime infra ch. 44, and self-employment tax, section 199A and the net investment income tax infra ch. 45. This chapter refers to those chapters and does not repeat them.
Organization. The chapter proceeds in nine parts:
- the framework of subchapter K and the aggregate and entity theories that run through it (¶ 4010);
- the contribution of property to an LLC under section 721, its exceptions, the character rules of section 724 and the contribution of services (¶ 4020);
- outside basis, inside basis and the adjustments to outside basis under section 705 (¶ 4030);
- disguised sales and disguised payments under section 707(a)(2) (¶ 4040);
- the allocation of LLC liabilities under section 752 (¶ 4050);
- the limitations on a member's use of losses under sections 704(d), 465, 469 and 461(l) (¶ 4060);
- the allocation of income and loss under section 704(b) (¶ 4070);
- contributed and revalued property under section 704(c), varying interests and interests created by gift (¶ 4080); and
- the anti-abuse rules, the basis-shifting guidance of 2024 and 2025, compliance, a summary table and a checklist (¶ 4090).
A note on sources and terms. The statutory references in this chapter are to the Internal Revenue Code of 1986, as amended through Pub. L. 119-21, 139 Stat. 72 (2025), and the regulatory references are to Title 26 of the Code of Federal Regulations as currently in force. The Code and regulations speak of partners and partnerships. In this chapter a member of an LLC classified as a partnership is a partner for tax purposes, and the terms are used interchangeably where the context is federal tax. The term outside basis refers to a member's adjusted basis in its LLC interest, and inside basis to the LLC's adjusted basis in its assets. The term book refers to amounts determined under the capital account rules of the section 704(b) regulations.