Passive Activity Loss

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Sample Comments on Proposed Passive Loss Restrictions

Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington, D.C. 20044
Attention:  CC:PA:LPD:PR (REG-109369-10)
Room 5203

I am writing to advise the Internal Revenue Service of my opposition to the Proposed Regulations (REG-109369-10) regarding the circumstances under which an LLC member will be treated as a limited partner under the passive loss limitations in I.R.C. § 469.  These Proposed Regulations would classify an LLC member as a limited partner if the LLC member does not have the right to manage the LLC at all times during the tax year under the terms of the LLC operating agreement and applicable state law.  Limited partner classification means that only three of the seven tests for determining material participation are available to the LLC member.  More importantly, limited partner classification means that the LLC member would be precluded from grouping the LLC’s equipment leasing activities with any other activity.  In the case of an aircraft leased by an LLC to a related business, this limitation on grouping would effectively deny the tax benefit of bonus or accelerated depreciation.

The Proposed Regulations Would Arbitrarily Apply the Limited Partner Classification to LLC Members in Common LLC Governance Structures

The Proposed Regulations require, in essence, that an individual must be named as a manager of the LLC with the right to contractually bind the LLC to avoid limited partner treatment. That limitation ignores the wide diversity of LLC structures that have evolved over the years. Many LLCs are structured in a manner similar to a corporation in which the managers are certain designated employees serving as the LLC’s officers. Whether a particular LLC member or another individual within the LLC is designated as a manager of the LLC is an arbitrary distinction and seldom has any relevance to the LLC member’s level of participation in the LLC or in the overall activity of which the LLC may be a part. There is simply no rational tax policy to be achieved by preventing the leasing activities in such LLCs from being grouped with the LLC member’s other business activities.

The Proposed Regulations Impose a Harsh Result on LLCs that Lease Equipment for Valid Business Reasons

It is a common business practice for equipment to be owned by one entity (such as an LLC) and leased to a related entity for valid business reasons.  Such an arrangement may be utilized to address requirements imposed by various stakeholders such as lenders, investors, or employees.  Equipment may also be placed in a separate entity and leased to an operating company to protect it from liability risks or to facilitate utilization by multiple entities.

Existing regulations do not allow taxpayers to group limited partnership interests in equipment leasing activity with other interests because of the different material participation tests.  This limit on grouping is a very harsh result, since the prohibition on grouping causes the limited partner’s share of tax losses of an equipment lessor to be suspended under the passive loss rules.  In the absence of any compelling tax policy reason, the Proposed Regulations should not extend this harsh result to LLCs that engage in equipment leasing for valid business reasons.

Congress Did Not Intend to Classify LLC Members as Limited Partners

In 1986, there were state law limitations on the ability of limited partners to participate in the management of a limited partnership.  The passive loss rules for limited partners reflect Congressional recognition that such state law limitations presumptively indicate that limited partners have a passive role in the business of a limited partnership.  Since there have never been state law limitations on the ability of LLC members to participate in the management of an LLC, there is no sound policy reason and no indication of Congressional intent to arbitrarily extend these harsh restrictions on grouping to LLC members.

The Proposed Regulations Frustrate the Intent of Congress To Encourage Growth in the Economy Through Bonus and Accelerated Depreciation

Congress has repeatedly acted in recent years to encourage investment by providing new rules for bonus and accelerated depreciation. By making equipment leasing by an LLC subject to passive loss limitations that defer depreciation deductions, the Proposed Regulations run counter to the clear intention of Congress. By frustrating Congressional intent to incentivize and reward the purchase of business equipment, these Proposed Regulations would hurt the U.S. economy at precisely the time when Congress is seeking to strengthen it.

The Proposed Regulations Create a Trap for the Unwary with Unnecessary Complexity

These new rules will undoubtedly create unnecessary complexity and uncertainty.  Many LLC members who are not formally listed as managers in their LLC agreements will be caught by these rules and will be surprised to find their depreciation deductions suspended.  These rules needlessly create unnecessary complexity in requiring a determination of which LLC members have a right to participate in management.  Furthermore, there are many complex multi-tiered organizational structures in which it will be very difficult to determine which individuals and which entities’ losses should be subject to the limited partner rule. 

The Proposed Regulations Are Not Necessary To Accomplish the Purposes of the Passive Loss Rules

The passive activities limitation rules were originally enacted primarily to address the perceived problem of syndicated real estate leasing activities in which investors bought limited partnership interests mainly for the tax benefits. There is no such need to impose a heightened material participation standard or grouping limitation for LLC members by treating them as limited partners under these rules. The seven tests for material participation are sufficient to prevent LLC interests from being syndicated to investors who purchase them merely for the tax benefits. Indeed, the Activity Regulations (1.469-4) have rules under which grouping of commonly-owned activities including rental activities is specifically permitted. It would be contrary to the intent expressed in the Activity Regulations for these new rules to arbitrarily expand the circumstances in which grouping is not permitted for equipment leasing by an LLC.


A number of judicial decisions over the past decade have made it clear that the federal courts do not agree with the IRS and do not regard LLC members as equivalent to limited partners for purposes of the passive loss limitations. The IRS should likewise recognize the spirit, intent and guidance of these judicial decisions, as well as the legal and practical differences between LLCs and partnerships, by refraining from arbitrarily extending the limited partnership classification to LLC members in the absence of any compelling tax policy reason.