IRS Loses Tax Case

The IRS lost a key battle in its fight to limit tax deductions that can be taken by investors in small businesses, The Wall Street Journal reports. The Tax Court decision would allow investors, in certain kinds of businesses, to deduct losses against salary and investment income.

The case, which involved Nebraska farmers seeking to deduct losses from their chicken and pig operations, can still be appealed by the IRS, but makes loss deductions much easier to obtain for some investors.

The decision specifically applies to investors in limited-liability companies, and limited-liability partnerships, and benefits those who actively work in several businesses.

The WSJ article uses this example: Suppose you have interests in two businesses, each organized as a limited-liability company. You work six hours a week in each of these businesses. Together they post losses of $175,000. You also have $200,000 of salary and investment income. According to the IRS, you have $200,000 of taxable income. But under the Tax Court decision you would have only $25,000 in taxable income, because the $175,000 loss can offset your other income.

The IRS has long taken the position that losses generated by businesses held within LLPs and LLCs cannot generally be used to offset salary and investment income. The IRS position has had the effect of forcing investors in LLPs and LLCs to delay loss deductions, sometimes for years. However, in the case the Tax Court issued a summary judgment saying the farmers were active investors who could properly deduct farming losses against other income. If the ruling stands, it will change a long-running battle over the tax treatment of losses incurred by LLCs and LLPs.