Continuing a Partnership LLC Alone w/o Tax Consequences

[kiki96]

I had a general partnership LLC go bad, where to make a long story short my partner lost interest from the get go and has now agreed to leave two years later. 

I want to give the business a real shot. I'd be investing my own money in creating content to run ads, but I don't want to do this if him leaving costs me money. Taking on the business already feels risky enough even though it's what I want to do. I don’t want to continue the business if it’s a tax burden to me for him to leave. My worry has been that his investment loss would be considered my gain. I recently met with a lawyer and he found that Revenue Ruling 99-6 would apply to our situation. 

I’m wondering if anyone can confirm that this is the correct tax procedure. The way the lawyer explained it to me is that removing my partner causes the LLC to be dissolved whereby for tax purposes we are treated as if 50% of the assets were just distributed to both of us. After the distribution I have then been considered to have “purchased” my partner’s share (he has requested 144 units of the product to walk away). So my partner will be taxed on half of the partnership when I close the books after he signs even though he’s walking away with only 144 units of product. I don’t really understand where that leaves me though. 

Honestly I barely understand this whole thing and unfortunately I can’t afford a CPA. If anyone could chime in with confirmation this advice is correct, or their own advice it would be hugely appreciated. I'm also wondering what forms I would need to fill out to correctly report all of this to the IRS. Below I’ve put some relevant numbers if it helps. 

My original investment: $19,690

My partner’s investment: $18,098

I have taken a $8k loss so far (tax years 2016 and 2017)

He has taken a $8k loss so far (tax years 2016 and 2017) 

Our gross profit in 2017 was $649 

The business has about $1000 in the bank currently 

The starting value of our 2018 inventory was reported as $18,000 on taxes 

He wants 144 units of product which have the raw cost value of $1,931 (retail would be much higher, but that is what they cost to make)

The business has no debt

[Carl]

Here's how this works.

First the partnership is dissolved. Then one that is done in it's entirety, you will be starting your own "new" business as a sole proprietor or single member LLC. For now, your only concern is dissolving the partnership and nothing else. Period.

To dissolve the partnership any and all assets must be disposed of in one way or another, and any cash assets must also be disposed of. Additionally, any and all debt of the partnership must be satisfied in it's entirety.

First, all the bills are paid, and if you have any recurring expenses such as rent for a storefront, notice is given as appropriate. Any early termination fees are also paid. All this stuff is paid by the partnership.

Next, all the inventory and assets if any, has to be disposed of. You just distribute this to each partner with the split based on their percentage of ownership. If done right, the distributions would basically be a return of capital investment of each partner, thus incurring no tax liability on the personal tax return of each partner.

Make sure the K-1 issued to each partner has the "FINAL" box checked to indicate it will be the last K-1 issued to that partner (including you) by the partnership.

When dealing with this you work with actual costs, and not retail value.

If there are any vehicles owned by the partnership then disposition of that vehicle by the partnership has to be accounted for too. But I suspect you don't have this situation so won't go into it. So this will take care of dissolving the partnership.

Are you with me thus far?

[kiki96]

Hey thanks so much for taking the time and yes, I think I'm with you. The only thing I'm not sure about is how it works when I'm continuing the business. Below is how the lawyer explained it to me. If you don't mind taking a look, does this sound correct to you? Also if you know the forms to actually implement this, I would love confirmation. My understanding is that I should file a short year 1065. I know that he gets a Final K-1. I'm not sure if mine is considered "Final" though. And then I also file a 8308 when I send in the 1065. From there I would just do a Schedule C of the business next April b/c I'm now a single member LLC. Actually I think this answers my question about my own K-1 being final. It will be the final one b/c that partnership LLC will be dead and I won't have to do K-1's anymore as a single member. 

Say we have 1800 units of product. My partner just wants 144 of them. I'm going to continue the business with the rest of them. According to rule 99-6, we close out by dividing everything in half for the final tax. This is how the lawyer explained it to me: 

"Because, an LLC is considered a partnership for federal tax purposes, the removal of your partner would be considered a dissolution of the partnership (because its a two person partnership) and the company would be deemed to make a liquidating distribution to both you and your partner.  Accordingly, you and your partner would be taxed as if you were both distributed 50% of the assets of the company and would pay tax on those distributions to the extent they exceed your respective adjusted basis in the LLC.

After the equal distributions, You would then be considered to have "purchased" your partner's share.  In the purchase agreement for partner's share, I would include some consideration, such as $100 or so and agree to indemnify him for all future LLC liabilities.  This will serve as the consideration for his interest. 

Effectively, your partner will be taxed on 1/2 of the partnership, even though he will only get 144 units.  Given the numbers you provided, it will likely be about a wash for him as his adjusted basis will offset the gain.  He will be left with a small loss ($351 or so).

[Carl]

" The only thing I'm not sure about is how it works when I'm continuing the business."

Understand that you are NOT continuing anything. You are closing one business, which happens to be a partnership, and then once that's complete you are opening an entirely new business that has no relationship what-so-ever to the closed business.

This is why you deal with things one at a time. So don't get ahead of yourself or you'll end up like Vinny Barbarino.... "I'M SO CONFUUUUUSED!!!" and you don't need that.

As for the other stuff, the lawyer is right. You split inventory 50/50 "ON PAPER". Then when you start your new business, that new business can buy back all or part of the inventory from the partner for a cost of $0 if so desired. But you will not deal with this now. Concentrate solely on dissolving the partnership as required by the law, and don't worry about opening a new business at this point. Continue "AS IF" you will not be opening a new business, for now.

You need to deal only with the dissolution of the partnership for now, because when we get to opening the new business you'll need assistance with reporting inventory or I can just about guarantee you that you'll report things wrong and get nasty grams from the IRS.

[kiki96]

Okay thanks!