Partnership liquidating distribution and example

For example, if the Estate recognizes the 0,000 of K-1 capital gain income on the sale of the assets in the same year that the corporation liquidates, it will be able to offset all of the 0,000 with the 0,000 capital loss on the corporate liquidation, with no net tax due as a result of the asset sale.

If the liquidation does not occur in the same year as the sale, the Estate will pay 1,000 in tax on the gain from the sale of the assets in one year and generate a 0,000 capital loss in a subsequent year.

The outside basis is the owners basis in their interests in the entity. Ball, the outside basis, is

For example, if the Estate recognizes the $940,000 of K-1 capital gain income on the sale of the assets in the same year that the corporation liquidates, it will be able to offset all of the $940,000 with the $940,000 capital loss on the corporate liquidation, with no net tax due as a result of the asset sale.If the liquidation does not occur in the same year as the sale, the Estate will pay $141,000 in tax on the gain from the sale of the assets in one year and generate a $940,000 capital loss in a subsequent year.

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For example, if the Estate recognizes the $940,000 of K-1 capital gain income on the sale of the assets in the same year that the corporation liquidates, it will be able to offset all of the $940,000 with the $940,000 capital loss on the corporate liquidation, with no net tax due as a result of the asset sale.

If the liquidation does not occur in the same year as the sale, the Estate will pay $141,000 in tax on the gain from the sale of the assets in one year and generate a $940,000 capital loss in a subsequent year.

The outside basis is the owners basis in their interests in the entity. Ball, the outside basis, is $1 million because there is a step-up in the basis of Mr.

million because there is a step-up in the basis of Mr.

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Inside and outside tax basis issues arise in other contexts, such as partnerships, but those situations are well beyond the scope of this newsletter.

Tax professionals, like football players in the 1940's, must keep their eyes on both the inside and outside.

For example, if N-Run sells all of its assets for $1 million, it will have gain based on the difference between the sale price ($1 million) and the inside basis ($60,000), or $940,000.

If N-Run is a C corporation, it will pay a corporate level tax on that gain, before anything is distributed to the shareholders.

This characterization problem can have some timing differences. The tax result of a section 83(b) election is not difficult in a corporate context, but raises issues in the case of partnerships. Under Code section 83, a service provider generally does not have a taxable event upon grant of an option because the option’s value is not readily ascertainable at the time of grant.[11] Upon exercise, the service provider will include as ordinary income the difference between the property’s fair market value and any price paid upon exercise. Thus, in the case of an option that is exercised when the value of the interest (and the underlying capital) is greater than the exercise price, as will often be the case, capital may shift from the existing partners to the optionee.

If the Service member is not a partner (by virtue of not having made a section 83(b) election), his share of income will not be allocated to him in the year it is earned, but, instead, the LLC will have a deduction in the year of that the Service Member is paid. If a section 83(b) election is made with respect to an LLC interest, the service partner is treated as the owner of (and is allocated the income attributable to) the restricted interest. Until that time, all the tax consequences of the exercise of an LLC option are not clear. In the partnership context, the exercise of an option may shift capital from the old members to the option holder, which could result in immediate income to the exerciser, under section 83 or section 721, in an amount equal to the excess of the value of the interest acquired over the amount paid for it. If the difference between value and exercise price (“spread”) is equal to the capital shift, regulation 1.721-1(b)(1) and section 83 are happily in agreement on the amount of income recognized by the optionee.

TAX ISSUES IN CONNECTION WITH PARTNERSHIP EQUITY COMPENSATION, OPTIONS AND RESTRICTED INTERESTS by Roger Royse 1. Limited liability companies (LLC)[1] have become a popular choice of operating entity in recent years due to (among other reasons) the recognition of limited liability companies by all 50 states, the “check-the-box” regulations, and the shareholder and single-class-of-stock limitations on S corporations. A threshold issue concerns whether an employee who receives an interest in an LLC (an “employee/member”) will be treated for tax purposes as a partner, an employee, or both. A serious entrepreneurial risk that a partner will not receive payments, or will lose his capital, indicates partner status. An employee relationship is indicated if the member’s interest in the LLC is small in relation to the payment or allocation in question. The IRS has consistently maintained that a person cannot simultaneously be an employee and a partner.

In order to compete for labor and capital, while retaining the benefits of a pass through entity, LLC’s are more frequently implementing capital structures that mimic traditional venture backed C corporations, including equity compensation arrangements. There may at times be a fine line between an employee with a bonus based on profits and a true partner. The lack of entrepreneurial risk may suggest an employer-employee relationship. Another factor that would support employee characterization is that the employee became a partner primarily for tax benefits. An attempt to reconcile the authorities might lead to the conclusion that an employee/member is probably more likely a partner for tax purposes if he or she has a right to vote on LLC matters, has an interest in capital as well as profits and losses, is liable to the other members for breach of fiduciary duties, and is not terminable at will or on short notice for non-performance. Upon issuance of the partnership interest, the former employee will find him or herself in a totally different tax regime. The cost of the first ,000 of group-term life insurance on the life of an employee provided by the employer may be excluded from his income. Nevertheless, Code[6] Section 707(a) seems to allow for the possibility of a dual status partner/employee.

Unless the Estate has sufficient capital gains to offset that loss, the loss would have to be carried forward, perhaps for a very long time.

If N-Run is an S corporation, because of the basis increase resulting from the corporate level gain and the step up in basis because of Mr.

Unlike corporate equity compensation, the treatment of compensatory LLC interests (or options on LLC interests) is uncertain, possibly unfavorable to the members, and may require complicated special allocations. The holder of a capital interest (as opposed to only a profits interest) probably has entrepreneurial risk; however, the issue is less clear when the interest is subject to vesting or other restrictions.[3] Because the grant of a profits interest represents only a right to future profits and appreciation, the receipt of a mere profits interest (as opposed to a capital interest) may be indicative of an employment rather than partnership relationship. An employee relationship is indicated if partner status is not permanent. An employee relationship is indicated if payment is closely related in time to the performance of services. In practice, persons treated as partner-employees might not have all (or any) of those attributes. Some significant differences in tax treatment between a partner and employee are as follows: i. A member is taxed on his or her distributive share of the LLC’s income, whether or not it is distributed. A member’s share of LLC income is not subject to withholding, except in the case of foreign members, but a member must make quarterly estimated tax payments. Even if the LLC continues to treat a holder of a very small income interest as an employee for the purposes described above, the LLC will still be obligated to provide the employee/partner with a K-1 showing their share of the LLC’s distributive share income. The value of health insurance provided to a member by the LLC is included in the member’s income as a guaranteed payment.[4] The member is generally allowed an above-the-line partial deduction for health insurance. An employee can exclude from income the value of meals and lodging as a fringe benefit or furnished for the convenience of the employer if, in the case of meals, the meals are furnished on the employer’s business premises, and in the case of lodging, the employee is required to accept such lodging on the employer’s business premises as a condition of his employment.[5] vii. Only employees may participate in a cafeteria plan. Section 707(a) contemplates that a partner may engage in transactions with the partnership in a capacity other than as a partner – as an employee, for example.

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