David Fielder is a management professor at the University of South Texas. During 2015, Dr. Fielder formed an LLC (classified as a partnership for federal income tax purposes) with one of his colleagues so they could provide management consulting services. Dr. Fielder and his colleague are managing members of the LLC, and they each spent 375 hours working on the activity. The LLC earned $100,000 in 2015, and Dr. Fielder and his partner split the profit equally. Besides the LLC, Dr. Fielder also has an investment as a limited partner in a limited partnership. Dr. Fielder is just a silent partner, and he does not spend any time participating in the business. In previous years, your firm has treated this investment as a passive activity. For the 2015 tax year, Dr. Fielder received a Schedule K-1 showing an ordinary business loss of $20,000. Since the consulting business is new for 2015, you and your manager are not sure whether it should be classified as a passive activity on Dr. Fielder’s tax return. If the activity is classified as passive, Dr. Fielder will be able to deduct his $20,000 loss from the limited partnership against his $50,000 of income from the LLC. In addition, you do not know how his distributive share of ordinary business income from the LLC and ordinary business loss from the limited partnership should be treated for purposes of the self-employment tax. Your boss mentions that there are special rules for limited partners, and she wonders whether the LLC members should be treated as limited partners for purposes of the passive activity and self-employment tax rules. Research these issues discussing the proper tax treatment.

Requirements:

1. Is Fielder’s partnership in the LLC treated as a limited partnership interest for purpose of the passive activity and self-employment tax rules?

2. Is the $50,000 of income from the LLC subject to the self-employment tax?

3. Is the $20,000 loss from the limited partnership deductible for the self-employment tax?

4. Is the LLC activity passive or active?

5. Can Fielder deduct the $20,000 loss from his investment in the limited partnership?

6. What is the seven steps test recommended by the IRS to determine if the LLC is passive and how many steps are required to determine if it is passive, and does he meet the steps required.