Partnership Taxation for Multi-Member LLCs
Unlike corporations, Multi-Member LLCs (MMLLCs) do not pay income tax directly. Instead, they act as conduits, passing profits and losses to members. This dashboard synthesizes the critical mechanics of Subchapter K: tracking basis, managing capital accounts, and structuring special allocations under the IRS microscope.
The Flow-Through
Income is reported on Form 1065 but taxed on individual returns via Schedule K-1. The LLC pays no tax; the partners do.
Capital Accounts
Tracks a partner's equity. Must be maintained via Tax Basis (for IRS) and 704(b) Book (for economic deals).
Inside vs. Outside
Two basis measurements exist simultaneously: the LLC's basis in assets (Inside) and the member's basis in their interest (Outside).
Why This Matters
For The Business
- Flexibility in profit sharing (Special Allocations).
- Ability to deduct losses against other income (subject to basis limits).
- Single layer of taxation (avoiding double tax).
The Risks
- Allocations lacking "Substantial Economic Effect" will be reallocated by the IRS.
- Losses in excess of basis are suspended.
- Complexity in tracking separate Tax and Book capital accounts.
Outside Basis Calculator
Outside Basis is your tax scorecard. It determines the taxability of distributions and the deductibility of losses. It starts with your contribution and fluctuates with entity activity. Use the controls below to simulate a tax year.
Simulate Events
Initial contribution established. Basis is positive, allowing for tax-free distributions up to this amount.
🏛️ Inside Basis
The LLC's adjusted basis in its own assets. This matters for calculating depreciation and gain/loss on the sale of assets by the LLC.
👤 Outside Basis
The Member's adjusted basis in their LLC interest. This matters for determining the taxability of cash distributions and the ability to deduct passed-through losses.
Special Allocations Engine
One of the greatest advantages of an MMLLC is the ability to Specially Allocate profits and losses disproportionate to ownership percentages. However, the IRS requires these allocations to reflect economic reality. Compare "Pro-Rata" vs. "Special" scenarios below.
Scenario Viewer
Ownership Interest
Fixed by Operating Agreement
Tax Allocation (P&L)
Dynamic based on Tax Year
Scenario: Standard Pro-Rata
Income is allocated exactly according to ownership percentages. This is the "Safe Harbor." It automatically has Substantial Economic Effect because tax follows the legal rights to liquidation proceeds.
Capital Account Maintenance
Money contributed, FMV of property contributed, and allocated Net Income/Gain.
Money distributed, FMV of property distributed, and allocated Net Loss/Deduction.
Book capital accounts must be adjusted to FMV upon certain events (e.g., new partner entry) to respect "Book-Ups."
Substantial Economic Effect (SEE)
For a special allocation to be respected by the IRS, it must pass the "Substantial Economic Effect" test under Treas. Reg. § 1.704-1(b)(2). If it fails, the IRS will reallocate income according to the "Partner's Interest in the Partnership" (PIP).
1. Capital Account Maintenance
The partnership agreement must require that capital accounts be established and maintained for each partner in accordance with specific accounting rules found in the Treasury Regulations.