Tracking outside basis is critical to properly taxing a partner on partnership distributions or on the disposition of its partnership interest, because in each case the partner's federal tax consequences derive directly from its outside basis in its partnership interest. Not so for the owner of a disregarded entity said the IRS Associate Chief Counsel in AM2012-001 (2/20/12). Tracking outside basis in a disregarded entity is irrelevant to the owner's taxation, and therefore, no authority provides for such tracking.

The legal ruling cites Rev Rul 99-5, 1999-1 CB 434, which explains the taxation of an owner who sells part of its interest in a disregarded entity and doesn’t mention a taxpayer's outside basis in the disregarded entity. Therefore, taxpayers owning 100% interest in LLCs that are disregarded entities cannot split their interests into separate classes of membership interests and then allocate income, loss, deduction, credit and basis among those classes for federal tax purposes in an attempt to manipulate the outside basis of the interests.