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).
There are tax consequences to each one of the retirement options. If Carol was to sell the business
and distribute part of the proceeds to each partner, this would have the biggest effect on partners. Each
one of the partners would have to recognize the gain or loss and return it on their personal tax returns
as income/loss or capital gains/losses. Which type would be dependent on the amount each partner
receives as well as the type of distribution. ‘A partner recognizes gain only if any money distributed
exceeds the partner’s pre distribution basis in his or her partnership interest’ (Rupert, 2019). ‘A
partner’s sale or exchange of a partnership interest would generate a capital gain or loss under SEC.
741 because a partnership interest is usually a capital asset’ (Rupert, 2019). It is important to establish
a formal plan because if Carol were to pass away prior to the sale. If there were a plan in place, no
changes would be made other than the proceeds going to the estate rather than Carol.
Before considering liquidating the partnership, Carol must first understand the certain procedures and
guidelines in doing so within the state her and her partners business is in. "Liquidation is the process
of settling all business liabilities and valuing and disposing of a business's assets. When your company
is organized as a partnership, liquidation involves state law and the way your business affairs are
structured" (Masters 2016 p 1). Since Carol is the only partner that plans on retiring, she should first,
review the partnership agreement they all prepared when they began the business. That would be the
first step on determining what needs to be done in order to continue the positive relationships between
all partners. In this case only one of the partners is ready for retirement, therefore selling the business
as a whole would be unfair for the other two partners, should they consider continuing with the
business based on the partnership agreement they formed at the beginning.
The best option in this case would be option 2: borrow money to pay for Carol's interest in the
business.
"Payments made in liquidation of the interest of a retiring or deceased partner in exchange for their
interest in partnership property are considered a distribution, not a distributive share or guaranteed
payment that could give rise to a deduction (or its equivalent) for the partnership" (IRS). This option is
more so the better option because they would not have to collectively agree to retire or sell the
business, the other two partners can continue it on nor would they have to, if they did not want to,
bring in another buyer to take over Carol's interest. Option 3 would be a good idea if the outside buyer
was a family member of Carol's or one of the other owners as they would already have some sort of
relationship with the business. "Upon the receipt of the distribution, the retiring partner or successor in
interest of a deceased partner will recognize gain only to the extent that any money (and marketable
securities treated as money) distributed is more than the partner's adjusted basis in the partnership. The
partner will recognize a loss only if the distribution is in money, unrealized receivables, and inventory
items. No loss is recognized if any other property is received" (IRS).
Should Carol pass away before this option is decided then the successor would become the partner in
her place. According to the IRS and for tax purposes, "a retiring partner or successor in interest of a
deceased partner is treated as a partner until their interest in the partnership has been completely
liquidated" (IRS). It is and would be a good idea for all partners in any partnership review and keep
the partnership agreement updated and as accurate as possible should anything, such as a death occur.
As Carol plans to retire from The Marina, marina owners Bob, Amy, and Carol have started to discuss
what will happen to Carols share of interest since she no longer wants to be actively involved in the
operations or decision making process of running The Marina. As they all have interest in The Marina
they all must decide together what to do with Carols share of interest. They have ruled out selling the
business as Bob and Amy wish to continue operations and Carol is okay with the continued operation
of The Marina after she retires. Taking on additional debt to buy Carol out also is an not an option
because Bob and Amy have no desire to take on additional debt to buy Carol out.
Bob and Amy have approached Carol with another alternative if she doesn't want to liquidate her share
of interest entirely she can find a buyer for her share of interest in the business. Carol is considering
this as the better alternative since it will allow The Marina to continue on without an interruptions into
normal business operations. Bob has done some research and found that the IRS has laid out some
specific guidelines around the sale of interest and the related transaction. Under IRS guidelines the
ownership interest in The Marina is treated as an asset that can be purchased or sold. Carol will treat
the proceeds from the sale of her interest as the sale of an asset and will pay a tax on the gain or loss
on sale of her ownership interest; and ownership interest must be sold are fair market value.
Bob and Amy will not be involved in the sale and Carol can sell her ownership interest to another
person, legal entity, partnership, or corporation as she pleases and after the sale she will notify Bob
and Amy that the sale has been completed. The sale will be reported on the Form 1065 tax return and
Carol will be issued a final K-1. Carols ownership interest accounts will be reduced to $0 z and the new
partners ownership interest will be increased to similar amounts. When the IRS reviews returns for
completeness and accrcury they take a look at these details to indicate if there was a sale of ownership
interest. Carol will also report the sale on her Form 1040 as Schedule D, Capital Loss or Gain and will
include Form 8949 and Form 4797 as needed. In Carols best interest she should ensure that the sale of
the transaction is reported according to IRS code, any deviation from the code could seen seen as
fraudulent intent or a motive to avoid paying taxes.
It is agreed upon that if Carol chooses to sell her ownership interest she would find a suitable buyer,
but in the event of her untimely death, Bob and Amy will have quite a tedious task on their hand to
reorganize the partnership if there is no formal agreement in place at the time of her death. If business
operations ceased altogether after Carol dies the partnership will have to be dissolved. Any income
made by Carol will be reported on her final return and her estate will have to decide rather they would
like to obtain ownership of her share in ownership interest. If Carols estate does not want to obtain her
ownership interest Bob and Amy may have to buy out her ownership interest or they could try to find
a suitable buyer for her share of ownership interest. In the worst-case scenario if Amy and Carol can't
find a suitable buyer or the estate does not obtain ownership interest, they will have to sell the business
completely or close down if services offered by Carol cause business activities to stop.
Bob, Amy, and Carol should review their partnership agreement to ensure that events such as untimely
deaths are addressed.
References
Ellentuck, A. (2015, August 1). Accounting for the Death of a Partner. Retrieved March 24, 2023,
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Rupert, T. J., & Anderson, K. E. (2023). Prentice Hall’s Federal Taxation 2022.
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Lessambo, F. (2021). US Taxation of Partnerships: Advanced Topics. Kluwer Law International BV.
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U.S. Bank. (n.d.). 6 Tax Considerations When Selling Your Business.
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