Importance of Maintaining Formalities with Your LLC: It Will Affect Your Deductions

Patrick J. Murphy

By Patrick J. Murphy

Many individuals establish LLCs and then operate a business as if it was an extension of themselves, commingling funds and not following proper formalities. A recent Tax Court decision provides a sobering realization for individuals who fail to properly title their assets and follow the required formalities. In this case, the court found that a taxpayer’s purchase of an RV did not increase the amount he had at-risk in the LLC because he could not show the LLC owned or used the RV. As a result, deductions he had taken based upon that amount at-risk were disallowed by the IRS.

In Estate of Roberts v. CIR, the taxpayer had established an LLC to lease equipment to his S corporation. He lent money to the LLC, which issued him a promissory note in that amount. With the proceeds of the loan, the LLC purchased an RV. However, there were several issues with the RV’s ownership and use. Even though the RV was titled in the name of CTI Leasing, it was not titled in the name “CTI Leasing, LLC,” the company’s legal name. The EIN on the car title belonged to his S corporation. The RV was not on the LLC’s depreciation schedule. The taxpayer used the RV for his own purposes. Lastly, there was no record that the LLC ever used the RV, because there was no written lease between the LLC and the S corporation concerning the RV.

As a result, the IRS concluded, and the Tax Court confirmed, there was no evidence that the LLC owned the RV or used it. Because the taxpayer could not show that the LLC owned or used the RV, the taxpayer was unable to claim tax deductions based upon the LLC’s capital at-risk in connection with the RV.

There are a few items to take away from this case:

  1. You should always properly title your corporate assets and use the corporate title LLC, Corp., or Inc., as the case may be.
  2. If you have multiple business entities, you must keep assets of each entity separate from other assets. If you lease an asset among entities, you must have a proper lease in writing executed by both entities.
  3. It would be much cheaper for the taxpayer to seek the guidance of an accountant or attorney when completing these transactions than suing the IRS in Tax Court for the disallowed tax deductions.

These days, with Legal Zoom and other ready-to-order LLCs, people are buying assets and operating businesses without knowing the consequences of their actions. Before you enter into large transactions, it is important to understand the formalities that must be followed in order to receive the intended tax consequences.

Posted by Attorney Patrick J. Murphy, CPA. As both an attorney and a CPA, Murphy’s practice includes sophisticated estate planning approaches as well as corporate transactions and advice in mergers and acquisitions, buy/sell agreements, corporate structuring, and real estate transactions for small to medium-sized businesses.


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