How did an LLC that elected out of federal partnership treatment compute earned surplus when members had different asset bases and depreciation methods?

Plain-English summary

An LLC that elected out of federal partnership treatment computed former taxable earned surplus using a pro forma Form 1065.

The LLC had to make the federal income-tax elections required of an LLC treated as a partnership. It computed asset basis as though it had not elected out, even though members could have different bases and depreciation methods for identical LLC interests.

The original first issue asked how to determine member contributions and company surplus without company books or contribution records. After the taxpayer revised the facts to say the LLC maintained books, records, and contribution records required by Texas LLC law, the Comptroller said no response to that issue was necessary.

What this means for you

LLCs making federal classification elections

The historical Texas computation reconstructed partnership treatment through a pro forma federal return rather than following each member's separate asset basis.

Tax professionals

Keep the response to Issue 2 separate from Issue 1, which the letter did not decide after the facts changed.

Common questions

Q: Which return formed the earned-surplus computation?
A: A pro forma Form 1065.

Q: How was asset basis computed?
A: As though the LLC had not elected out of partnership treatment.

Q: Did the letter decide the no-records scenario in Issue 1?
A: No.

Citations and references

• 34 Tex. Admin. Code Sec. 3.562(c), (d)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9801264L

Original ruling text

January 15, 1998

Dear Mr. **:

In your letter of August 6, 1997, you asked for a determination regarding the
franchise tax treatment of an LLC electing out of partnership status.

At that time, I responded to Issue #3 of your inquiry. Below I have restated
Issues #1 and #2 with responses.

Issue #1

A limited liability company is normally taxed as a partnership for federal
income tax purposes but may elect out of partnership status in some instances.
If electing out, no federal tax return would be prepared determining member
contributions, company income and resulting allocations to members.
Furthermore, in some instances no books for the company would be required when
members could determine their share of company items independent of each other
as in a joint venture. How then are member contributions and company surplus
to be determined if at all as required under Rule 3.562(c) and (d) when a
limited liability company elects out of partnership status particularly when
members are responsible for and capable of determining their own individual
shares of taxable income? Please keep in mind that no such contributions have
been actually made to the LLC as described in Rule 3.562(c), nor have any
allocations been actually made by the LLC to its members for federal income tax
under Rule 3.562(d).

Response

In our telephone conversation on September 18, 1997, you indicated that the
fact situation should be changed to indicate that the LLC maintains both books
and records and a record of contributions made as required by the Texas Limited
Liability Company Act. Based on the changed facts, there is no response
necessary for Issue #1.

See the response to Issue #2 regarding the computation of earned surplus.

Issue #2

In connection with Issue #1 above where an LLC has elected out of partnership
status, it is further possible for members to have a different tax basis in
depreciable assets from other members holding identical interests in the LLC.
If the LLC described in Issue #1 above is still required to somehow determine
member contributions and company surplus, how would depreciation be determined
for earned surplus purposes particularly when the asset basis and depreciation
methods among members differ?

Response

The LLC should compute the net taxable earned surplus based on a pro forma Form
1065. The LLC would make any federal income tax elections required of an LLC
which is treated as a partnership for federal income tax purposes. The basis
of assets should be computed based on amounts as if the LLC had not elected out
of partnership treatment.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have any questions, contact Tax Policy Division. You may call toll free
1-800-531-5441, or our regular number is 512/463-4600. My extension is 3-4662.
You may write me at Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Bob Jeffcoat
Tax Policy Division