united-states tax-law partnership
Can sole member LLC add 1% partnership to deduct large business expenses?
<p>A sole member LLC has business expenses that can only be partially deducted from the individual's taxes because they far exceed the company's income.</p>
<p>The company changes to a partnership adding an individual but with only 1% interest.</p>
<p>The new partner contributes cash to the company to cover the business expense deficit and then deducts that same amount as a business expense from their new company from the taxes on their own existing income.</p>
<p>By diverting an amount that would have been paid to the IRS to their new company and then deducting that same amount, the overall transaction nets to zero but the company covers it's business expenses.</p>
<p>Can partners only deduct business expenses proportional to their interest in the company?</p>
<p>Even if they made an equivalent cash contribution to the company?</p>
<p>Can someone only deduct business expenses from taxes on income from that business only or all of their income regardless of the source?</p>

<h2>Contributing cash to a company is not tax deductible</h2>
<p>It’s either a capital contribution or a loan; either way it’s not an expense deductible to the individual (nor income to the company).</p>

<p>@DaleM's answer is correct as far as it goes.</p>
<p>Neither loaning the company money, nor investing in it as an equity investment, is deductible.</p>
<blockquote>
<p>Can partners only deduct business expenses proportional to their
interest in the company?</p>
</blockquote>
<p>In an entity like an LLC taxed as a partnership, the allocation of items of income and expense in the company must have &quot;substantial economic effect&quot; which means that they must correspond to the economic reality of the company.</p>
<blockquote>
<p>Even if they made an equivalent cash contribution to the company?</p>
<p>Can someone only deduct business expenses from taxes on income from
that business only or all of their income regardless of the source?</p>
</blockquote>
<p>In addition to the &quot;substantial economic effect&quot; rule there are several other limitations on taking losses.</p>
<p>One is the &quot;at risk&quot; rule which provides that you can't take more in losses from the venture than that maximum amount you could lose, which in an LLC would usually be your capital investment in the company.</p>
<p>Another is the &quot;passive loss&quot; rule which provides that a person who is not actively involved in a business may only use losses from passive activities to offset income from passive activities.</p>
<p>Yet another fairly newly enacted additional limitation is the <a href="https://www.becker.com/blog/accounting/theyre-back-2021-loss-limitations" rel="nofollow noreferrer">excess business loss limitation</a>.</p>
<blockquote>
<p>The excess business loss limitation applies to noncorporate taxpayers
and does not allow a loss that exceeds $262,000 (unmarried) or
$524,000 (married) for 2021. The threshold amounts are adjusted
annually for inflation. An excess loss not allowed in the current year
is carried forward as a net operating loss. After a loss passes the
hurdles of tax basis, at risk, and is not considered passive, the loss
cannot exceed the excess business loss limitations.</p>
</blockquote>
<p>And, if the business ceases to be profitable year after year (i.e. if it is not profitable for at least three of the last five tax years, unless it is a horse racing business), the <a href="https://sharedeconomycpa.com/blog/irs-hobby-loss-rules" rel="nofollow noreferrer">hobby loss rule</a> also disallowed net operating loss deductions from the LLC.</p>
<p><strong>Footnote</strong></p>
<p>The LLC could elect to be taxed as a C-corporation or an S-corporation, rather than under the default regime that applies to multiple member LLCs which is to be taxed as a partnership.</p>
<p>In an LLC taxed as a C-corporation entity level losses cannot be reported on shareholder tax returns. Federal income taxation takes place at the entity level, and shareholders are taxed only on actually distributed dividends and on capital gains from the sale of their stock.</p>
<p>In an LLC taxed as an S-corporation, a simplified variation on partnership style pass through taxation is used, but all items of income and expense must be allocated on a pro-rata basis. So, a 1% shareholder is allocated 1% of the company's net operating losses - subject also to the &quot;at risk&quot;, &quot;passive activity loss&quot;, and excess business loss limitations discussed above.</p>
<p>But, purchases of membership interests in LLCs and loans to LLCs that are taxed as C-corporations or as S-corporations are still not tax deductible.</p>
