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Credit Limits for Limited Liability Companies

June 2009 - If you are the owner of a disregarded entity, including a single member Limited Liability Company (LLC), the amount of credit you can claim may be limited.

Utilization of the credits attributable to the activities of a disregarded entity which are otherwise allowed is limited to the increase in the owner's regular tax, (tax before reduction by any credits), that results from including the income and expenses attributable to the disregarded entity. Determining the credit limitation requires several steps. First, the owner computes its regular tax on all its income, by including in its income the income and expenses attributable to the disregarded entity. Second, the owner then recalculates its regular tax excluding the income and expenses attributable to the disregarded entity, and subtracts this amount from the first amount. The positive difference between the first and second amounts of tax, if any, is the limitation on the amount of credits of the disregarded entity that the owner may use for the tax year. If the second number is greater than the first number, the owner is not allowed to use any credits from the disregarded entity.

Example 1

The SMLLC generated an enterprise zone hiring credit of $25,000. The single member is either a C corporation or an S corporation with total net income, including the income (loss) attributable to the activities of the SMLLC, of $50,000. The income of the corporation excluding the income (loss) of the SMLLC, however, is $100,000. In other words, the SMLLC generated a loss of ($50,000). Assume the tax rate on the C corporation is the regular 8.84%, and the tax rate on the S corporation is 1.5%. The minimum corporate franchise tax is $800.

Tax including income C corporation S corporation
Net income of SMLLC ($50,000) ($50,000)
Net income of member excluding LLC’s net income $100,000 $100,000
Total net income reported by member $50,000 $50,000
Tax $4,420 $800
     
Total net income of member excluding income/loss attributable to SMLLC $100,000 $100,000
Tax $8,840 $1,500
     
Credit allowable 0 0

 

In this case, no credit from the disregarded LLC can be claimed, since the member's regular tax including the disregarded LLC is less than the member’s regular tax excluding the income attributable to the disregarded LLC.

Example 2

The SMLLC generated an enterprise zone hiring credit of $25,000. The single member is either a C corporation or an S corporation with total net income, including the income attributable to the SMLLC, of zero. The income (loss) of the corporation excluding the income of the SMLLC, however, is ($100,000). In other words, the income attributable to the SMLLC is $100,000.

Tax including income C corporation S corporation
Net income of SMLLC $100,000 $100,000
Net income of member excluding SMLLC’s net income ($100,000) ($100,000)
Total net income reported by member $0 $0
Tax $800 $800
     
Total net income of member excluding income/loss attributable to SMLLC ($100,000) ($100,000)
Tax $800 $800
     
Credit allowable 0 0

 

In this case, no credit from the disregarded LLC can be claimed, since the member's regular tax including net income of the disregarded LLC is not any more than the member’s regular tax excluding the net income attributable to the disregarded LLC. 

Example 3

The SMLLC generated an enterprise zone hiring credit of $25,000. The single member is either a C corporation or an S corporation with total net income, including the income attributable to the SMLLC, of $50,000. The income of the corporation excluding the income of the SMLLC, however, is ($50,000). In other words, the net income attributable to the SMLLC is $100,000.

Tax including income C corporation S corporation
Net income of SMLLC $100,000 $100,000
Net income of member excluding SMLLC’s net income ($50,000) ($50,000)
Total net income reported by member $50,000 $50,000
Tax $4,420 $800
     
Total net income of member excluding income/loss attributable to SMLLC ($50,000) ($50,000)
Tax $800 $800
     
Credit allowable $3,620 0

 

In this case, for the member that is a C corporation the allowable amount of the credit is $3,620 provided the corporation's tax attributable to the zone is equal to or greater than the $3,620. However, under the enterprise zone rules there may be an additional limitation. The member that is the S corporation would not be allowed to use any credit to reduce the S corporation’s minimum tax, since no credits can reduce tax below the minimum amount.

The shareholders of the S corporation will also have run the numbers to determine their limitations on use of the credit, since the limitation also applies to indirect owners to whom credits flow. Consider example 2 above. If member X owned the S corporation that owned SMLLC 100 percent, member X would receive a schedule K-1 reporting $0 (no income/no loss). When you run the numbers excluding the SMLLC income of $100,000, however, the schedule K-1 would have reported a loss of ($100,000). To the extent that including the $100,000 income of the SMLLC in the income on the S corporation increases member X's own regular tax, the credit that passes through would be allowable to member X. Depending on member X's other reported income, you would think in Example 2 that the total regular tax liability computed by excluding the SMLLC's income would be less than the original reported tax, since the total taxable income should be less. However, depending on passive activity loss limitations and the other limitations on reporting S corporation losses, the taxable income, and therefore the tax, might not be less.