Partnership Termination

[MJG CPA]

A 20% partner walked away from the partnership (took some clients with him). Only one partner remaining, so for tax purposes, we dissolved the p/s last year and converted it to a sole proprietor business. The partners have finally decided to draw up a formal dissolution agreement. No assets or money will change hands. The 20% partner simply ceases his involvement with the business.

I do not see any tax ramifications of this transaction. Am I missing anything?

[OldJack]

What happened with the dissolved capital accounts? Did the 20% partner get his fair share of the business or did the other partner have a gain from his leaving?

[MJG CPA]

What happened with the dissolved capital accounts? Did the 20% partner get his fair share of the business or did the other partner have a gain from his leaving?

That's where I'm having trouble. Originally, the partner was admitted to the business with no buy-in - he received a 20% allocation from the other partners capital accounts in exchange for the services he contributed to the partnership. And on the way out, he received nothing (allegedly due to self-dealing and a breach of his fiduciary duties in taking p/s clients with him when he left). The entire business has very few assets and the total partners' capital accounts show $25k at the end of the year.

I simply converted the capital accounts to retained earnings on the sole proprietor balance sheet, but am wondering now if there should be any gain/loss considerations between the partners?

[BulldogTom]

<<No assets or money will change hands. The 20% partner simply ceases his involvement with the business>>

That partnership interest must have had some value (positive or negative). That value was transfered to the remaining partner, which is an acquistion of a partnership interest to him, and a disposition of a partnership interest to the minority partner. In addition, the value of the client list that the minority partner took should also be evaluated. He may have traded the client list (intangible asset) for his partnership interest?

Are there any debts in the partnership that the majority partner assumed? or that the minority partner is relieved of?

There are many questions that need to be answered before any determination of tax consequences is made. And if I am reading this correctly, the partnership disolution only memorializes what happened LAST YEAR, when the tax consequences would apply.

Tom

Lodi, CA

[MJG CPA]

I guess the desire of both partners is to achieve a break even. The remaining partner retained all business assets and liabilities with net assets (partner capital accounts) of $25,000. The partner who left took a significant amount of business with him. Both partners agree to call it an even swap.

Is there any wording in the final dissolution that can achieve a net zero tax consequence on both sides?

[OldJack]

The 20% partner had his capital account that represented his book tax basis and was due him on liquidation. If he abandoned his equity he has a tax transaction on his 1040 Sch-D as though he sold his interest in the business with a capital gain or loss. The 80% partner has purchased such equity at no cost (with no increase in outside tax basis but with an increase in his book basis) and nothing is reportable.

[BulldogTom]

I guess the desire of both partners is to achieve a break even. The remaining partner retained all business assets and liabilities with net assets (partner capital accounts) of $25,000. The partner who left took a significant amount of business with him. Both partners agree to call it an even swap.

Is there any wording in the final dissolution that can achieve a net zero tax consequence on both sides?

OK, this may not be correct, but if I remember my partnership classes, you may be able to get to that result.

I think you need to do a complete close of the book at the time of the split, and get a complete accounting of the capital accounts. Get the hard assets accounted for next. Hopefully, you will be short about 5K (25K X 20%). Value the intangible for the difference. Distribute his capital back to him in the form of the intangible. It is creative accounting, but if you do it correctly, it might work so long as all the income is properly accounted for and included on the K-1s.

This is total unresearched. I am not an expert on Partnership taxation. I am just recalling some stuff from some classes I took.

Tom

Lodi, CA

[DANRVAN]

I would skip the creative accounting, look at the facts and apply the law. You can’t pull a number out of the hat and call it Goodwill.

Look at Rev. Rul. 99-6, 1999-1 CB 432 -- IRC Sec(s). 708, 1/15/1999, it will refer you to various code sections and analysis of various situations where a two man partnership is liquidated and one partner continues the business.

The partner who continues the business ends up with two sets of assets: first those attributable to his partnership interest (basis being his partnership interest); and secondly, the assets he bought from his partner, the basis being the consideration he gave for them.

My impression is that the 80% P purchased the remaining 20% of the assets by assuming his partner’s 20% share of the liabilities. He obtained 80% of the assets through a liquidating distribution; those assets are allocated according to his basis in the partnership interest and his holding period includes the holding period of the partnership. The basis of the other 20% of the assets is the consideration he gave for them; the 20% share of the liabilities he assumed. A new holding period starts for these assets.

The 20% guy has a deemed distribution equal to his share of the liabilities assumed by his partner, and figures gain or loss accordingly.

You should also look at Rev Rul 93-80, 1993-2 CB 239 which discusses character of gain or loss upon abandonment of partnership interest.

Good luck

Dan

ps when you book the entry for the sole proprietor you credit his capital account instead of retained earnings.