An advance of cash by a part to a liability that is limited (LLC) classified as being a partnership can be by means of a money share or financing. This difference has tax that is significant. For instance, a capital share advances the adding user’s foundation inside the or her LLC interest on a buck — for — buck foundation, but a loan escalates the member’s basis just by a sum add up to their or her increased share of LLC liabilities under Sec. 752. (nonetheless, that loan from a part or user affiliate generally speaking is allocated 100% compared to that user for foundation purposes underneath the Sec. 752 guidelines.)
Bona fide debt
The transaction is treated as a loan from a third party if an advance from a member to an LLC is bona fide debt. Under this kind of arrangement, re re re payments of principal and interest are taxed as though the mortgage had been between unrelated events. The lender/member states interest earnings based on his / her accounting technique. Likewise, the LLC deducts the attention compensated towards the known user based on the LLC’s accounting technique. Nonetheless, the deductibility regarding the interest payments might be susceptible to associated — celebration guidelines managing the timing associated with deduction.
The parties should execute a promissory note to evidence the loan in the same way a note would be executed if the loan were made to an unrelated third party for the loan to be respected as a third — party debt. Your debt tool needs to have a set payment date and supply for sufficient interest that is stated. Other facets that recommend a part is real financial obligation are (1) the user’s directly to seek a safety curiosity about LLC property (it could be a good notion to provide the member a secured fascination with LLC home), and (2) terms that mirror commercial reasonableness — such as for instance waiver of need, presentation, and notice; directly to attorney’s costs; and guarantee by other people. See PK Ventures, T.C. Memo. 2006 — 36 , for a great conversation of just exactly exactly what constitutes bona debt that is fide.
People must be aware that 3rd — celebration lenders may necessitate subordination of this user financial obligation as an ailment of creating a loan, specially if the user’s debt is guaranteed by LLC home.
If a part makes loans towards the LLC throughout every season therefore the LLC regularly repays the loans, the practitioner may choose to start thinking about starting a master loan arrangement that allows the LLC to determine a credit line aided by the user. The master loan contract should retain the terms that are normal language includible in a line — of — credit contract. This alleviates the requirement to report each loan on paper and enables the practitioner to review the mortgage terms yearly.
Example 1. Loan from a user to an LLC: D has a 25% desire for P LLC, that is categorized being a partnership. D lends the LLC $52,000 on Sept. 1 to pay for uncommon running costs when it comes to 12 months. Both D and P are cash — basis taxpayers. The LLC signs a need note calling for yearly re payments of easy interest on Dec. 31 of every 12 months at a sufficient rate of interest.
D has carefully documented this deal. He’s got a finalized note through the LLC installment loans SC calling for payment of major plus interest at a rate that is adequate. The note ought to be addressed as that loan for taxation purposes rather than as being a money share. The LLC deducts the interest cost as a trade or company cost. D’s Schedule K — 1 , Partner’s Share of money, Deductions, Credits, etc., through the LLC will not mirror the attention re re payment through the LLC. D states the attention re re payment on their specific return as interest earnings.
The interest — like payments are taxed as guaranteed payments if the amount loaned to the LLC is actually contributed capital.
E will treat $1,000 (100% Г— $1,000) of her interest earnings as passive task earnings. This represents E’s interest earnings ($1,000) increased by her share of passive interest cost from all known user loans ($1,500) split by the higher of (1) E’s share of R’s interest cost from all user loans ($1,500), or (2) her interest earnings from R ($1,000).
P will treat $1,500 (75% Г— $2,000) of her interest earnings as passive task earnings. The $1,500 represents P’s interest earnings ($2,000) multiplied by her share of R’s passive interest cost from all known user loans ($1,500) split by the more of (1) P’s share associated with the LLC’s interest cost from all user loans useful for passive tasks or elsewhere ($1,500), or (2) her interest income from R ($2,000).
Loans from LLCs to members
The LLC receives interest income that will, in turn, be passed through to the members if there is a loan from an LLC to a member. The self — charged concept applies (Regs if the member uses the loan proceeds in a passive activity. Sec. 1. 469 — 7 (d)). The user can recharacterize some or every one of his / her share of LLC interest income from all loans to users. The total amount recharacterized as passive may be the user’s share regarding the LLC’s interest earnings from all loans to people multiplied by the user’s passive interest cost compensated towards the LLC and divided because of the greater of (1) the user’s interest cost ( otherwise or passive) paid towards the LLC or (2) the user’s passthrough share associated with the LLC’s interest earnings from all loans to people (used in passive tasks or elsewhere).
