I agree the three managers need an attorney and probably a tax accountant as well. They can split the cost between them since they have the same legal and tax issues.
For reference, let’s consider a slightly simpler case. Suppose each manager was left 10% of the company in the will. They pay no income tax on the inheritance received. Then, the owner's family wants to buy back the 10% ownership stake. When the manager sells their ownership stake back to the family, they only have a taxable profit (capital gain) if they sell their share for more than it’s fair market value on the date the previous owner died. Assuming the restaurant business was about equally as valuable on a day the previous owner died and the day the manager sells their shares back, then there is no capital gain, so none of the sales proceeds are taxable income. The payment should never be reported as wages. This is the sale of an asset from one person to another, and would be treated for tax purposes as if the manager had sold their used car (or any other asset) to the owner’s family.
This actual situation is indeed more complicated, and either you have not explained all the relevant facts, or I do not understand them. For example, I don’t know what the managers actually received in the will — did they receive profit participation without an ownership stake? Is that even possible? Maybe the profit participation does give them an ownership stake of some kind. The lease is a separate asset. It has a fair market value, although that may be difficult to calculate, because while the lease entitles the lease holder to operate a restaurant on a certain piece of property, it also obligates the leaseholder to pay certain rent.
I would say that if the owner’s family buys out the lease from the managers, that is a capital transaction. The managers would realize a capital gain or capital loss depending on the fair market value of the lease and the amount they received. These funds should never be reported as wages.
I am less sure about buying out the profit participation. That’s something that I’m just not familiar with.
In any case, I hope those general thoughts are helpful to you, but the managers really do need professional legal and tax advice. If the buyouts were reported as wages and the family refuses to fix the issue, there is a way to make a correction on the person’s tax return, but this really requires professional intervention.
