Losses When Closing an LLC

Generally businesses close because they are not profitable, and as a result have to deal with losses. Losses are important to the individual taxpayer because they can be used to offset taxable income both now and in the future. However closing a limited liability company is a unique proposition as it can be taxed as either a corporation or a partnership. So the effect of losses when closing an LLC depends significantly on how the LLC was treated during its existence.

LLCs and Taxes

An LLC is a business organization that is a hybrid of a corporation and a partnership. An LLC can elect to be treated as a partnership by the IRS. Then the LLC's annual earnings are taxed only once, with the profits and losses being divided on a pro rata basis among the owners and being taxed there. This is different from the corporate tax model, where the corporate entity is taxed annually, and those earnings are taxed again when the corporation distributes funds to its owners. Most LLCs will take advantage of the partnership option and LLC's are considered partnership by default with the IRS. But some LLCs elect to be treated like a corporation.

LLC Taxed as Partnership

There are two phases to dealing with losses with a closing LLC that is treated as a partnership. The first concerns losses resulting from the business activity in the last year of the LLC's operation. Those losses should be reported to you on your K-1, which is a form detailing your share of the partnership's current year activities. The losses can be used on your tax return to offset current year taxable income.

The second phase deals with losses that may arise from closing a partnership that is now worth less than what you invested. In this case, these amounts are reported as a capital loss and can be used only to offset other capital gains.

LLC as Corporation

The tax implications are much more straightforward in a liquidation, which is what happens to an LLC that was treated as a corporation that is sold or closes its doors. The business would sell all of its assets and settle all liabilities, and buy back all of your stock with the proceeds. If what you receive back is less than you what you paid for the stock, and you held your shares for longer than a year, you report a capital loss. If you held the shares for less than a year, you report an ordinary loss to be used to offset ordinary income.

Tax Tips and Disclaimer

For complex returns, it is a good idea to consult with a certified public accountant or licensed attorney, as they can best address your individual needs. Be sure to keep your tax records for at least seven years, to protect against the possibility of future audits. Every effort has been made to ensure this article's accuracy, but it is not intended to be legal advice.

References

• IRS; LLC Filing as a Corporation or Partnership; 2011
• IRS; Limited Liability Companies; 2011
• Cornell University Law School, Legal Information Institute; Subchapter P --- Capital Gains and Losses; 2010
• IRS; Publication 3402 --- Taxation of Limited Liability Companies; 2010.
• Cornell University Law School, Legal Information Institute; Subchapter K-- Partners and Partnerships; 2010.
• Cornell University Law School, Legal Information Institute; Section 331 --- Gain or Loss to Shareholders in Corporate Liquidations; 2010.