LLC Startup - Members' Basis

[newllcguy]

Please help! I am a member of a New York multi-member LLC (taxed as partnership) formed in 2010. All members are employees. We have elected the cash method of accounting for tax purposes.

For 2010, the LLC has a net loss. However, only one of the members has basis (or at least easily-determined basis) because he put in cash for membership.

One other member contributed intellectual property (difficult to determine value) but no cash. The rest of us earned our membership through sweat equity and unreimbursed business expenses.

The issue is: how can we each deduct our allocable share of the 2010 net loss (we each have other income to offset)?

I see two possibilities (but don't know if either is correct):

1) Record a basis for the estimated value of IP contributed and unreimbursed business expenses. Take as much of the allocable loss on 2010 Schedule E as the basis will permit.

2) Record basis of zero, but carry forward the allocable 2010 loss to a future tax year when basis is greater than zero.

I've asked my tax advisor and he doesn't know. Please help, smart people!

 

[davew128]

I've asked my tax advisor and he doesn't know. Please help, smart people!

Get a tax advisor who knows partnership law who can read your membership agreement.

 

[newllcguy]

I spoke to a friend's tax advisor who basically said "it's an LLC so you can do whatever you want". I don't find that answer or attitude comforting. If we all could afford a great advisor, no one would ask questions on this forum.

I have the operating agreement. I believe these are the relevant points:

- There is no clause that prevents members from being reimbursed for out-of-pocket expenses of the business. There is a clause that says "managers will be reimbursed for all reasonable expenses incurred in managing the Company."
- “Capital Contribution” means any Member’s contribution to the capital of the Company in cash, property, services rendered or a promissory note or other binding obligation to contribute cash or property or to render services.

Can anyone help with my question?

 

[LdiJ]

I spoke to a friend's tax advisor who basically said "it's an LLC so you can do whatever you want". I don't find that answer or attitude comforting. If we all could afford a great advisor, no one would ask questions on this forum.

I have the operating agreement. I believe these are the relevant points:

- There is no clause that prevents members from being reimbursed for out-of-pocket expenses of the business. There is a clause that says "managers will be reimbursed for all reasonable expenses incurred in managing the Company."
- “Capital Contribution” means any Member’s contribution to the capital of the Company in cash, property, services rendered or a promissory note or other binding obligation to contribute cash or property or to render services.

Can anyone help with my question?

In a start up situation each of you will have basis based on your contributions/investment towards the company. The cash investment is obvious, as you stated. The intellectual property counts but needs to be assigned a reasonable value and needs to be reflected in the balance sheet as an asset of the LLC. The cash investment also needs to be reflected in the balance sheet as owner equity.

The unreimbursed employee expenses also count as investments in the company. However, they also need to be reflected as actual expenses of the LLC and then reflected as investments by the members in the balance sheet.

Therefore, its not just a question of tracking basis for the purpose of taxes, you also need proper accounting records that reflect the transactions that have happened within the company. Its also not simply a question of you each reporting transactions on Schedule E on your personal returns. The LLC must file either a 1065 or an 1120S (if you made an S-corp election) and issue a K-1 to each of the members reflecting their share of the loss and other tax attributes.

Basis is also an ongoing issue. Losses claimed reduce basis, profits earned and additional investments increase basis.

 

[tranquility]

I agree with both Dave128 and LdiJ and emphasize this should have been handled all ready. At this point you will have some argument between the members regarding valuation.

 

[davew128]

The intellectual property counts but needs to be assigned a reasonable value and needs to be reflected in the balance sheet as an asset of the LLC.

I agree but I suspect there might be no basis to the contributing partner regardless of the valuation.

 

[tranquility]

I agree with this too. It is likely there was little investment in creating the IP and there is no history of profitability (As with a mailing list.) to show valuable rights.

This is a mess. It is going to take money to solve it as the government will care too. I would be happy if they came into the office as there will be a lot of billable hours figuring out what to do exactly and would probably include hiring a valuation expert. The quick and dirty way would be to keep the basis outside the LLC and count zero inside. Let the member handle it on his own and keep the books of the LLC clean.

 

[davew128]

Agreed. Quick and dirty. Unless there is a compelling reason to keep book basis capital accounts, keep it on a tax basis.

 

[LdiJ]

I agree with this too. It is likely there was little investment in creating the IP and there is no history of profitability (As with a mailing list.) to show valuable rights.

This is a mess. It is going to take money to solve it as the government will care too. I would be happy if they came into the office as there will be a lot of billable hours figuring out what to do exactly and would probably include hiring a valuation expert. The quick and dirty way would be to keep the basis outside the LLC and count zero inside. Let the member handle it on his own and keep the books of the LLC clean.

Tranq, we have no idea what the intellectual property is...I am not sure that we should automatically assume it has no proven value.

I also have a bit of a concern about advising someone to make all the basis outside basis. I recently went through an audit with a client whose basis was all outside basis and concretely proveable. The auditor then decided to audit the LLC before clearing my client's audit.

My client is going to be in a much better position, in my opinion, if the inside/book basis mirrors my client's contributions. However its possible that I could be overly conservative.

 

[tranquility]

It would be great to get it all on the books. But, as I wrote, it is almost assuredly going to be expensive, time consuming and sure to bring up an argument between the members. The quick and dirty way certainly has some risk too. The cost/benefit calculation can only be made once all the facts are known.