The IRS recently released a chief counsel memorandum AM2014-003 on LLC Member Guarantees of LLC Debt and “Qualified Nonrecourse Financing.” These memorandums are very helpful because they provide the IRS’ interpretation of complicated issues. These memorandums do not have the force and effect of law – thus a taxpayer is not bound by them. However, it is wise to thoroughly consider them.
The at-risk rules are complicated, but in a nutshell, these rules serve to limit the amount of losses that a business can deduct if it suffers losses. The losses are limited to the amount the taxpayer is economically or actually at risk for the investment.
This situation normally arises where a company has taken a loan to fund its operations. Some loans cause the taxpayer to be economically at-risk, like a “recourse” loan. Others do not, like a “nonrecourse” or “guaranteed” loan.
Limited liability companies have some peculiarities due to state law rules. Generally, in the case of an LLC, all members have limited liability with respect to LLC debt.
In the absence of any co-guarantors or other similar arrangements, an LLC member who guarantees LLC debt becomes personally liable for the guaranteed debt. If called upon to pay under the guarantee, the guaranteeing member may seek recourse only against the LLC’s assets, if any.
The IRS holds in its Memorandum that:
Therefore, in the case of an LLC treated as a partnership or disregarded entity for federal tax purposes, we conclude that an LLC member is at risk with respect to LLC debt guaranteed by such member without regard to whether the LLC member waives any right to subrogation, reimbursement, or indemnification against the LLC, but only to the extent that,
(1) the guaranteeing member has no right of contribution or reimbursement from persons other than the LLC,
(2) the guaranteeing member is not otherwise protected against loss within the meaning of § 465(b)(4) with respect to the guaranteed amounts, and
(3) the guarantee is bona fide and enforceable by creditors of the LLC under local law.
Oftentimes, when an LLC is created to carry on a business not much thought is put into tax consequences. It is important to consider the at-risk rules. Failure to consider will result in a less advantageous result when tax time comes.