Google Answers Logo
View Question
 
Q: Tax implications of selling LLC membership interest ( Answered 5 out of 5 stars,   1 Comment )
Question  
Subject: Tax implications of selling LLC membership interest
Category: Business and Money > Accounting
Asked by: acheslow-ga
List Price: $25.00
Posted: 22 Nov 2006 15:50 PST
Expires: 22 Dec 2006 15:50 PST
Question ID: 784943
I was a non-managing member of an LLC that repurchased my entire
membership interest in the company (6.25%). This transaction occurred
in conjuction with the sale of most of that company's assets to
another company. My membership interest (as
well as the membership interest of several other non-managing members)
was distributed between the two managing members and one remaining
non-managing member. How should I report this on
my taxes (regular income, captial gains, ?), and is there anything I
can do to minimize the impact?

Clarification of Question by acheslow-ga on 22 Nov 2006 15:55 PST
One other data point in case it matters -- I used the proceeds
indirectly towards the purchase of a new house (downpayment and
upgrades).

Request for Question Clarification by denco-ga on 22 Nov 2006 16:44 PST
Howdy acheslow-ga,

What monies, if any, did you have invested in the LLC?  Thanks!

Looking Forward, denco-ga - Google Answers Researcher

Clarification of Question by acheslow-ga on 23 Nov 2006 09:54 PST
No money invested in the LLC; my membership interest was granted as
part of an employee agreement. I never received a salary but did
receive one distribution from the LLC.

Thanks!
Answer  
Subject: Re: Tax implications of selling LLC membership interest
Answered By: richard-ga on 23 Nov 2006 18:26 PST
Rated:5 out of 5 stars
 
Hello and thank you for your question.

Most people who receive funds on liquidation of an LLC can expect to
pay capital gains rates on the gain in their LLC investment.  So you
might expect, since your investment was zero, to simply pay capital
gains rates on what you get.  And it's possible you will get that
benefit, if the LLC on its federal income tax return Form 1065 and the
K-1 that it issues to you give the liquidation that treatment.
http://www.irs.gov/pub/irs-pdf/f1065.pdf
http://www.irs.gov/pub/irs-pdf/f1065sk1.pdf

But the Internal Revenue Code has a different rule for property issued
in exchange for services:

 83. Property transferred in connection with performance of services
(a) General rule 
If, in connection with the performance of services, property is
transferred to any person other than the person for whom such services
are performed, the excess of?
(1) the fair market value of such property (determined without regard
to any restriction other than a restriction which by its terms will
never lapse) at the first time the rights of the person having the
beneficial interest in such property are transferable or are not
subject to a substantial risk of forfeiture, whichever occurs earlier,
over
(2) the amount (if any) paid for such property, shall be included in
the gross income of the person who performed such services in the
first taxable year in which the rights of the person having the
beneficial interest in such property are transferable or are not
subject to a substantial risk of forfeiture, whichever is applicable.
The preceding sentence shall not apply if such person sells or
otherwise disposes of such property in an arm?s length transaction
before his rights in such property become transferable or not subject
to a substantial risk of forfeiture.
http://www4.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000083----000-.html

The only other issue is <when> you should have paid that income tax. 
If the money that you're receiving now was previously subject to a
substantial risk of forfeiture, the time to pay the tax is <now.>  But
if you could have legally demanded the money at an earlier date, you
should have paid the tax <then.>  This issue probably won't affect
you, but it's currently a hot area and recent Treasury Regulations are
pressing for taxation at the earlier date.

If you want to know more, here's a summary of where the law stands currently:
Partnership Equity For Services - - New Rules Apply
http://www.sglaw.com/Article_BUS_18.html

Thanks again for letting us help.  It's a technical area, and the best
I could do was to give you the actual words of Code Section 83 since
they provide the ultimate authority on this question.

Search terms used
Partnership Equity For Services
Section 83

Request for Answer Clarification by acheslow-ga on 30 Nov 2006 13:32 PST
Thanks Richard, I have a few questions on your answer...

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?

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?

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.

Thanks!
Alan

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
acheslow-ga rated this answer:5 out of 5 stars and gave an additional tip of: $10.00
Very thorough, thanks for taking the time to provide a full and clear answer.

Comments  
Subject: Re: Tax implications of selling LLC membership interest
From: abezon-ga on 22 Nov 2006 17:21 PST
 
You'll pay capital gains taxes on the difference between your adjusted
basis & the proceeds of sale. Depending on the nature of the LLC, you
may have section 1250 unrecaptured gains and/or ordinary income.

Take every tax return & K-1 since you bought into the LLC with you
when you get this year's taxes done, as your tax preparer will need
them to figure your basis correctly.

You are not eligible for a like kind exchange, so buying a house is
irrelevant to this issue.

In future, ask about minimizing the tax impact of things *before* you
do anything. After is too late.

Important Disclaimer: Answers and comments provided on Google Answers are general information, and are not intended to substitute for informed professional medical, psychiatric, psychological, tax, legal, investment, accounting, or other professional advice. Google does not endorse, and expressly disclaims liability for any product, manufacturer, distributor, service or service provider mentioned or any opinion expressed in answers or comments. Please read carefully the Google Answers Terms of Service.

If you feel that you have found inappropriate content, please let us know by emailing us at answers-support@google.com with the question ID listed above. Thank you.
Search Google Answers for
Google Answers  


Google Home - Answers FAQ - Terms of Service - Privacy Policy