Option 1: Sell the business and distribute part of the proceeds to each
partner
Considering Bob, Ann, and Carol's business is a partnership, if they
were to sell the business and distribute some of the proceeds to
partners, there would be a few tax consequences for both the
partnership and the partners. There are two options when selling a
business, you can either sell the stock option or sell the company's
assets (U.S. Bank, n.d.). With a partnership being a pass-through
entity, the best option for pass-through entities would be to sell the
company's assets. This option would steer the seller away from
additional taxes that they would face if they characterized a sale of
stock. With the sale of the company's assets, the proceeds would be
distributed to each partner and would most likely be recognized as a
long-term capital gain. Long-term capital gains are subject to 20%
federal capital gains tax, and depending on the state, it could be
subject to additional state taxes. Buyers would typically prefer
purchasing a company's assets as well, because most tax laws allow
for the buyer to deduct the purchase price of the asset. If Carol were to
die before the sale of the business, her portion of the estate would be
subject to large estate taxes (U.S. Bank, n.d.). This is why it is
recommended to set up a thorough and up-to-date estate plan. This
way they could set up annual gifts to family or organizations that meet
the annual gift tax limit, therefore they wouldn't be subject to gift tax
and this would reduce the value of the estate, reducing estate taxes. In
partnership business context, liquidation refers to the process in which
the business is wound up and the assets are distributed among the
partners. In the context of the partnership marine business that was
established several years ago by Amy, Bob and Carol, one of the
partners (Carol) has decided to retire. An available option that can be
considered is to sell the business that belongs to Carol so that the
processed can be distributed among the remaining partners. In case
such a decision is made, it is essential to take into account the tax
consequences. In case the partnership is a pass-through entity, it will
not have to pay any corporate tax. According to the Internal Revenue
Service (IRS), in the case of partnership business, instead of paying
tax, it has to the ‘pass through’ the losses or profits to the partners
(Partnerships: Internal Revenue Service). In case the marine business
is a pass-through entity, it will not give rise to any tax implications at the
business level, instead, the profits or losses of the partners will be
passed on to them on which individual tax returns will be applicable. It
is necessary to carefully understand how tax can be treated so that the
assets of the partner can be carefully transferred (Jestl, 2021). In case
the partnership business is structured as a corporation, then the
possibility of double taxation may arise. This is because the tax will
have to be paid at the corporate level as well as at the individual
partner level. As in the specific context, out of the three partners, only
Carol has decided to retire, the sale of the business and the
subsequent distribution of her part of the proceeds to each partner will
give rise to taxation implications only at the partner level as they will be
taxed just like they are taxed on their personal income.If Carol dies
before the plan relating to the sale of her portion of the business is
executed, the tax implications are likely to vary. Generally, when a
partner dies, his portion of assets as well as liabilities, get passed on to
their respective heir. In terms of taxation, it is instrumental to make
appropriate adjustments in order to make sure that the assets of the
deceased partner reflect the fair market value of Caro’s share during
the time of her death. It is instrumental to do such an adjustment since
it can help to decrease the taxable increase in the deductible loss when
the assets are sold in the future. In case the partnership agreement
includes an option relating to a buyout of Carol’s share, the amount of
money relating to the buyout would be subject to estate tax. The other
surviving partners i.e., Amy and Bob would have to report such as
amount as taxable amount so that appropriate tax computations can be
made. It has been identified that in the case of partnership liquidation, it
has to make liquidating distributions as per the positive capital account
balance of a partner (Lessambo, 2021).
Reference
Jestl, S. (2021). Inheritance tax regimes: a comparison. Public Sector
Economics, 45(3), 363-385.
Lessambo, F. (2021). US Taxation of Partnerships: Advanced Topics.
Kluwer Law International BV.
Partnerships: Internal Revenue Service (no date) Partnerships |
Internal Revenue Service. Available at:
https://www.irs.gov/businesses/partnerships (Accessed: March 23,
2023).
U.S. Bank. (n.d.). 6 Tax Considerations When Selling Your Business.
https://www.usbank.com/wealth-management/financial-
perspectives/financial-planning/business-owners/sell-your-business-
taxes.html
