ACCT 616 Week 4 Discussion Board Forum 3 Example

Discussion Board Forum 3: Passive Activity Losses From an LLC Interest

ACCT 616 Advanced Topics in Individual and Pass-through Taxation, Discussion Board Forum 3

Thread by [Student Name]

The owner, business and classmates are composites; the Code section, regulations, cases, article and Bible passage cited are real.

Dr. Simone Hart, an anesthesiologist, owns 25 percent of Riverside Table LLC, which runs a restaurant managed by a full-time salaried general manager. She spends about 160 hours a year on the business, mostly reviewing menus and attending monthly meetings. The LLC lost $80,000 this year, and her $20,000 share appears on her Schedule K-1. She wants to deduct it against her salary.

Under Section 469, losses from a business the owner does not materially take part in may offset only passive income, so everything turns on her participation (I.R.C. § 469, 2025). The statute treats a limited partnership interest as passive except as regulations provide. Because LLC members, unlike limited partners, may take part in management, the Tax Court held in Garnett v. Commissioner (2009) that they are not limited partners for this purpose, which leaves all seven regulatory tests open, and the Court of Federal Claims reached the same view that year (Thompson v. United States, 2009). She still fails them. She works fewer than 500 hours; her 160 hours exceed 100 but are less than the manager's; and the facts-and-circumstances test is unavailable because someone else is paid to manage the business (Treas. Reg. § 1.469-5T, 2025). Her $20,000 loss is passive and suspended. Membership opens the door to the tests, but only hours carry the owner through it.

Proverbs tells the owner to know well the condition of the flocks and give attention to the herds (English Standard Version Bible, 2001/2016, Proverbs 27:23). An owner who wants to be treated as active should be able to show it, which in tax terms means a contemporaneous log of hours and duties, not an estimate built at filing time. Dr. Hart should keep one and carry the loss forward.

Reply to Owen

Owen, you were right that Garnett turned on the members' legal right to take part in management rather than on what they actually did. The Court of Federal Claims reached the same result in Thompson v. United States (2009), holding that a member of an LLC was not a limited partner for the material participation rules because state law did not limit his role. Together, the two decisions mean that a member is presumed eligible for every test unless the operating agreement or state law imposes limited-partner-style restrictions. One caution is that the regulations still speak of limited partners in terms written before LLCs were common, and proposed rules from 2011 that would have modernized the definition were never finalized. So practitioners should look closely at the operating agreement before relying on either case, especially for a member of a member-managed LLC (Treas. Reg. § 1.469-5T, 2025).

Reply to Hannah

Hannah, you asked whether Dr. Hart's suspended loss is simply lost if she never meets the tests. It is not. A disallowed passive loss carries forward to later years and can offset passive income from any activity, including future profits from the restaurant. When she disposes of her entire interest in a fully taxable transaction to an unrelated buyer, the remaining suspended loss becomes deductible against any income (I.R.C. § 469, 2025). Nash (2016) examines whether a complete redemption of S corporation stock counts as that kind of disposition, which shows how much rides on the form of an exit. For an LLC interest, a sale to the other members at fair value would usually qualify, while a gift would not; the suspended loss would instead be added to the recipient's basis. That makes the hours log worth keeping even in years when the loss is small.

References

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Garnett v. Commissioner, 132 T.C. 368 (2009).

I.R.C. § 469 (2025).

Nash, C. Y. (2016). Recognition of passive activity losses in a complete redemption of S corporation stock. The ATA Journal of Legal Tax Research, 14(1), 43-57. https://doi.org/10.2308/jltr-51481

Thompson v. United States, 87 Fed. Cl. 728 (2009).

Treas. Reg. § 1.469-5T (2025).