If an individual has passive losses from an LLC due to Section 179 deductions, can those passive losses be used to offset active income from an S corporation on their personal tax return?
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No, passive losses from an LLC (taxed as a partnership) due to Section 179 deductions generally cannot be used to offset active income from an S corporation on an individual’s personal tax return, unless the S corporation income is also passive with respect to the taxpayer. Here’s a detailed explanation based on the relevant law and IRS guidance:
1. Passive Activity Loss Limitation (Section 469)
General Rule:Section 469(a) disallows the deduction of passive activity losses (PALs) against nonpassive income for individuals, estates, trusts, closely held C corporations, and personal service corporations. Instead, passive losses can only offset passive income, not active (nonpassive) income such as wages, business income from activities in which the taxpayer materially participates, or portfolio income (interest, dividends, etc.).
Definition of Passive Activity:A passive activity is any trade or business in which the taxpayer does not materially participate, and all rental activities (with some exceptions).
Section 179 Deductions and Passive Losses:If a Section 179 deduction is claimed by a partnership (or LLC taxed as a partnership), and the deduction is allocated to a partner who does not materially participate in the activity, the deduction is treated as a passive loss to that partner.
2. Application to S Corporation Income
Active vs. Passive S Corporation Income:- If the individual materially participates in the S corporation’s business, the S corporation income is nonpassive to the individual.- If the individual does not materially participate in the S corporation’s business, the S corporation income is passive to the individual.
Offsetting Rules:- Passive losses from the LLC can only offset passive income from other sources, including passive S corporation income.- Passive losses cannot offset active (nonpassive) S corporation income (i.e., income from an S corporation in which the taxpayer materially participates).
Example:If you have a $10,000 passive loss from an LLC (due to Section 179) and $20,000 of active S corporation income (from an S corporation in which you materially participate), you cannot use the $10,000 passive loss to offset the $20,000 active income. The passive loss is suspended and carried forward to offset future passive income or until you dispose of your entire interest in the passive activity in a fully taxable transaction.
3. Special Allowance for Rental Real Estate (Not Applicable Here)
There is a special $25,000 allowance for rental real estate activities with active participation, but this does not apply to general passive losses from non-rental LLC activities or to Section 179 deductions unless the activity is rental real estate and the taxpayer meets the active participation requirements.
4. Reporting and Carryforward
- Disallowed passive losses are reported on Form 8582 and carried forward to future years.
- They can be used to offset future passive income or deducted in full in the year the taxpayer disposes of their entire interest in the passive activity in a fully taxable transaction to an unrelated party.
5. Summary Table
6. Conclusion
Passive losses from an LLC (including those from Section 179 deductions) cannot be used to offset active S corporation income on your personal tax return. They can only offset passive income, including passive S corporation income, or be carried forward to future years.
If you need to determine whether your S corporation income is passive or nonpassive, you must apply the material participation tests as described in IRS Publication 925 and the Instructions for Form 8582.
If you have further questions about material participation or the grouping of activities, please provide more details about your involvement in the S corporation and LLC.
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