Disregarded Entity May Select Different Accounting Method than its Owner

Posted by Todd Keator and Lee Meyercord          In a recent Chief Counsel Advice (“CCA”), the IRS determined that a disregarded entity for federal income tax purposes (the “LLC”) operated a separate and distinct trade or business from that of its owner (the “Company”) and therefore could select a different method of accounting. The Company’s activities include sales, marketing, distribution, sales support, research and development, and administrative and headquarter functions.  The LLC primarily manufacturers products that it sells to a third party and provides some research and development services.  After the LLC sells the products to a third party, the products are eventually sold to the Company.  The Company and the LLC maintain separate books and records, are in different geographical locations, and do not share employees other than high-level executives. Under Section 446(d), a taxpayer that is engaged in more than one trade or business may use a  different method of accounting for each trade or business.  The regulations provide that in order to use a different method of accounting for each trade or business, the trade or business must be “separate and distinct” and that no trade or business will be considered “separate and distinct” unless the taxpayer keeps a complete and separate set of books and records for the trade or business.The IRS found that the LLC’s status as a disregarded entity for federal income tax purposes did not prevent the LLC from operating a “separate and distinct” trade or business from the Company.  In addition, the IRS determined that, based on the available facts, the LLC and the Company operated separate and distinct trades or businesses for purposes of Section 446(d).  The CCA is available here. If you have any questions about the recent CCA or accounting method issues, please contact one of us or any of the other Tax lawyers at Thompson & Knight.