Back to basics: LLC passthroughs

You hopefully noticed that the really great benefits of Section 1202 and Section 1045 were focused on C-Corps. They don’t apply if you invest in an LLC. Do LLCs have some alternative benefits? Yes, they do: pass-through losses.

As quick background:

  • An LLC is a “passthrough entity,” which means that the LLC itself files tax returns but doesn’t pay any taxes; the individual “members” (the shareholders) do instead. If the company makes or loses money, the profit or loss leads to taxes the members have to deal with, not the company.

  • Startup companies generally lose money. Initially this is deliberate; later on, perhaps less deliberate but making money is hard.

So when you invest in an LLC, there’s a good chance you will be “passed” a loss to deal with in your tax affairs. That is (counter-intuitively perhaps) good news: investors can use those losses to reduce the ordinary income they have to pay (ordinary income) taxes on. (And remember that reducing ordinary income is better, because of the higher ordinary income tax rate.) They can also do it today, rather than this loss being stuck inside a C-Corp forever.

(Notice the similarity to passing on of depreciation costs in real estate investing…)

Some people invest in LLC just for this benefit.