Help with partnership technical termination

[skauk]

1.  There are 5 partners in an existing partnership.  One partner owns 50% and the remaining 4 each own 12.5%.  At the end of last tax year, 4 of the partner's had negative capital accounts due to losses throughout the years.    The LLC (partnership) operating agreement does not say anything about how to handle the negative capital accounts.

 

2.  On December 1, 2015 the partnership ownership changed.  The 50% partner and 3 of the 12.5% partners left - the other remaining partner reduced his interest from the 12.5% to 12.2233% and the new partner entered with 87.7767% ownership.  The new partner did not contribute cash or anything but instead assumed a partnership debt of $345,134.89.

 

Now, I know that since more than 50% of the ownership changed this caused a technical termination of the partnership.  And I know that I will have to file two short year tax returns.  But, here are some questions that I don't know how to handle for sure and I have found some conflicting advice:

 

a)  How do I get rid of the partners with negative capital accounts?  How is this reported on their respective K-1's?  Does it create a taxable income situation for them?  Can I just leave the negative capital accounts and mark the K-1's as final and then that leaves it up to each shareholder to report the negative capital on their personal returns?  Or do I need to add income to the K-1's in order to get the capital accounts to zero.  If so, what line do I report that income on the K-1? and is it capital gain income instead of ordinary income?

 

c)  Should the ending balance sheet of the old partnership be zero with a statement showing what the ending balance sheet was before the termination?  Some advice I have found says yes while others say no - just that the ending of the old should be the beginning of the new.  But how do I show the ones with negative capital - are they shown as negative or zeroed out?

[schirallicpa]

I remember years ago dealing with a similar situation and at the time I was working for a larger firm, so I did the front end work on the return, and then the managing partner finalized.  So I'm digging thru cobwebs.  But as I remember, the Partner leaving with negative capital ultimately had income on his K-1 for the forgiveness of debt.  It doesn't seem fair and it has made me tell all my clients to avoid partnerships.  But if you think about it, it will make sense and if you work thru the debits and credits, the accounting will put it where it belongs.