Clarification of Answer by
richard-ga
on
30 Nov 2006 15:25 PST
1) The LLC was not liquidated. *Most* of its assets were acquired and
it changed its name, but it still exists under the management of the
same two original managing members. The money that I received was in
exchange for giving back my membership interest in the LLC. Does this
change your answer?
--This doesn't change my answer, but let's go on to #2.
2) It's not clear to me whether my membership interst was actually
"property transferred in connection with performance of services" or
not. I suppose I could argue either way depending on which is more
beneficial. Are there other ways that my membership interest could be
treated?
--There aren't that many ways a person receives a membership interest.
Basically they either make a capital contribution, or they earn the
interest by providing services. If the former, then distributions
from the LLC (your point #1 above) reduce their capital account and
they don't owe any tax until they've recovered their investment, after
which they generally pay capital gains tax on what they get. If the
latter, then when they receive distributions (or sooner if their
interest was not subject to a substantial risk of forfeiture) it's
ordinary income to them.
3) At the time I was granted my memership interest in the LLC it was
worth practically nothing. Does this mean I should have claimed $0
income from it when I got it, and then I'd be done? That doesn't make
sense to me.
-- If on Jan 1 your interest was issued to you and at that time the
LLC was worth nothing and you had just started to work for it, then on
Jan 1 you had no income. But if by Dec 31 you had provided no capital
but had rendered $30,000 worth of "free" services, the LLC in a sense
owes you $30,000. The timing question is when you should first pay
income tax on that $30,000. If your LLC interest was subject to a
substantial risk of forfeiture, for example if you quit on the last
day of the year you'd lose that $30,000 stake, then you won't owe
income tax until a later year when you do get a distribution. While
if your LLC interest was not subject to a substantial risk of
forfeiture, such that had you quit on Dec 31 you would have been able
to require them to pay you the value of your interest then that's the
year you would have owed income tax even though you got no cash.
Finally, if you're paying ordinary income tax on the distribution as
payment for services, the LLC is allowed an income tax deduction for
what it pays you, which reduces the tax burden on the owners of the
LLC including you in proportion to your share. But if it was a
capital distribution, you'll pay capital gains tax (once your capital
account is exhausted) but the LLC will not get an income tax deduction
for the payment, so the owners of the LLC including you will pay
income tax on the LLC's profits without the benefit of that deduction.
Needless to add, this is a very complicated and technical area, and
you'll have to read a lot more than what I have room to type here to
gain a full understanding of the issues. Here is some additional
material to review:
http://www.irs.gov/businesses/partnerships/article/0,,id=134691,00.html
http://www.bdo.com/about/publications/tax/taxpresentations/NewTaxRulesforPartnershipsandLLCs.pdf
http://rothgerber.com/newslettersarticles/taxtips.pdf
http://www.cadwalader.com/assets/article/060606SwartzLaymansGuide.pdf
://www.google.com/search?sourceid=navclient&ie=UTF-8&rls=GGLH,GGLH:1969-53,GGLH:en&q=llc+taxation+section+83+capital+account
