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Thursday, March 01, 2012

IRS DOES NOT RESPECT SPLIT ELIGIBLE ENTITY INTEREST TRANSACTIONS

An owner of an interest in a disregarded entity, such as a sole owner of a domestic LLC, is treated as incurring directly the income and expense items of the entity – hence the term “disregarded.” Some taxpayers have taken to creating multiple types of interests in disregarded entities, based on various preferences or types of income or properties held by the LLC. This is akin to a partnership being able to define different interests in property, income and expenses among its partners.

In the partnership scenario, different partners will obtain different outside basis in their interests over time, as different types of income and expense are allocated to them. Sole owners of LLC’s that create similar disparate interests assert that each such interest has its own separate adjusted basis computation. This can allow for tax manipulation of the basis of interests for sale, upon distributions, and other purposes. For example, if the owner sells part of his ownership interest in the LLC, he or she may assert that the adjusted basis (for gain/loss determination purposes) is not a pro rata portion of the underlying basis of the LLC assets, but perhaps is higher than that (and the proportionate adjusted basis of the interests not being sold) due to the above allocations.

No way, says the IRS in Associate Chief Counsel Legal Advice. A disregarded entity will not allow for the creation of interests with different tax attributes in the hands of its sole owner. This makes sense, but you have to admire the creativity of some of these tax planners.

Office of Chief Counsel Memorandum Number AM2012-001 (February 9, 20120

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