To base my observation on option one which was to sell the business
and distribute part of the proceeds to each partner because, in my
opinion, it is the most straightforward option for the partners. When the
partners sell the business, assuming they are all equal partners, then
we can insinuate each partner will receive an equal amount from the
sale. Then the gain or loss from the sale will pass through to the
partner's personal tax returns. Therefore, each partner could claim the
amount of their basis tax-free on their income taxes. If the distribution
is more than their basis, then they will be required to have to report a
gain on their tax returns. Gains are generally taxed as long-term capital
gains, therefore if the partners have held an interest in the partnership
for more than a year then they will pay lower tax rates on the gain than
they would on a partnership’s operating profit. Also, if the distribution is
less than their basis, then it would be best if they will report a loss. If
the partnership distributes property to the partners, there is no tax
effect until the property is sold. However, before any of the partners
receive a distribution, all debts will need to be paid off, which means
the remaining amount would be distributed to the partners.
Now if we were to look at Carol, if Carol were to die before they sell the
partnership, the partnership would dissolve, then the assets are sold to
pay debts, and then the remaining amount is distributed to the other
partners. Another option would be to look for a clause in the
partnership agreement that specifies what shall happen to the
partnership in the case of a death. This would be ideal since it
specifically says what is to happen to the partnership, which simplifies
things and allows the partnership to potentially avoid probate court.
When one partner wants to leave the business, the simplest solution is
to ask them to find an outside buyer for their stake and keep the sale
isolated to that. This solution is easier than the other two, because
buyers need less money than they would to buy the whole thing, and
the other partners don’t need to borrow anything.
The IRS (n.d.) explains that when the sale of a partnership interest
occurs, it is done by the entity theory, not the aggregate theory. That
means the interest that the partner holds, not a portion of the
underlying assets within the business. So, essentially whatever Carol
sells her piece for above the value of her total basis represents her
gain. Furthermore, Anderson et al. (2023) explains that the gain or loss
created from this sale represents a capital gain or loss under Sec. 741.
However, when the asset is IRC 751, they must recognize ordinary
income or a loss. The same thing goes for a Sec. 1250 asset, which is
subject to an unrecaptured gain. As far as the rest of the partnership
goes, when a buying partner acquires a stake at, the other partners can
elect to make a special IRC 743(b) basis adjustment and use the new
given value as their FMV.
If Carol were to pass away before the plan is executed, it makes things
a bit more complicated. New York Life (n.d.) explains that the first
important thing is that the partners have a plan for if this were to
happen. Generally, the heirs to Carol's estate will take hold of the
business. The entire business could be liquidated, the heirs can
become new associates, their stake can be sold, or the other partners
could buy it out. We know that since Carol was going to sell the
business, her heirs likely would as well. They simply will inherit the
shares at Carol’s basis and sell them the same way she would have.
IRS. (n.d.). Sale of a Partnership Interest. Retrieved from:
https://www.irs.gov/pub/irs-utl/sale_of_partnership_interest.pdf
Anderson, K., Hulse, D., and Rupert, T.,. Prentice Hall’s Federal
Taxation 2023 Corporations, Partnerships, Estates & Trusts. 2023.
New York Life. (n.d.). What to do if your business partner dies.
Retrieved from: https://www.newyorklife.com/articles/your-business-
partner-died-tonight
Anderson, K., Hulse, D., Rupert, T. (2023). Prentice Hall Federal
Taxation 2023: Corporations, Partnerships, Estates, and Trusts.
