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.
While the three options presented in this week discussion are all unreasonable when liquidating a
partnership or settling the interest for the death of a partner. I would recommend option 3 is the
best option choice, asking Carol to find an outside buyer for her portion of the partnership will
require Carol to recognize the gain/loss associated with the sale of a capital asset. Accordingly,
the third-party buyer will assume the share of partnership forward. Section 751 states she can
exclude unrealized receivables and inventory items. The gain/loss is the difference between the
sale proceeds and the partner’s (Carol’s) interest. According to The CPA Journal (2021), “IRC
Section 751, the selling partner (Carol) is required to recognize ordinary income to the extent of
any gain attributable to IRC section 751 property (or “hot assets”). “Hot assets are defined to
include unrealized receivables (e.g., rights to payment under either goods or services contracts)
and inventory items. Only the excess, if any, of the purchase price over the amount characterized
as ordinary income or loss is treated as capital gain.”
The course textbook reads: “When one partner sells his or her partnership interest, the sale
usually has no more impact on the partnership than the sale of corporate stock by one shareholder
has on the corporation. Only the partner and the purchaser of the interest are affected. However,
the partnership itself is affected if the partnership interest sold is sufficiently large that, under Sec
708, its sale terminates the partnership for tax purposes (Anderson & Rupert, 2023).”
If Carol becomes deceased, then her partnership interest can be sold to one or more existing
partners or to an outsider. Sometimes a deceased partner’s successor-in-interest exists (the party
that succeeds the rights of the deceased partner’s interest) from the partnership to receive
payments from the partnership not to exceed the deceased partner’s interest in the business. The
partnership can make payments in exchange for the partner’s interest in partnership property and
other payments (Anderson & Rupert, 2023). Carol is able to retire without Amy and Bob having
to sell the marina, or take out a loan in order to purchase Carol’s share of the business. But, what
will this do to their partnership? This will depend on the partnership agreement that was,
hopefully, established at the conception of the partnership. If Carol leaves, the partnership may be
dissolved without ending the business. However, a new partnership agreement will need to be
created to include the buyer of Carol’s interest in the business. Additionally, the partnership
agreement should have laid out a plan for this type of situation. There are a few tax consequences
that Carol may face should she choose to sell. Per IRC § 741, “in the case of a sale or exchange
of an interest in a partnership, gain or loss shall be recognized to the transferor partner. Such gain
or loss shall be considered as gain or loss from the sale or exchange of a capital asset, except as
otherwise provided in section 751 (relating to unrealized receivables and inventory items” (LII,
n.d.). When it comes to any liabilities that the marina has, Carol will be relieved of these when
she sells to a new partner. So, the sale amount to the new partner will include cash given, FMV of
noncash property, and Carol’s share of the liabilities.
Legal Information Institute. (n.d.). 26 U.S. Code § 741 - recognition and character of gain or loss
on sale or exchange. Legal Information Institute. Retrieved March 23, 2023, from
https://www.law.cornell.edu/uscode/text/26/741
Anderson, K., Hulse, D., Rupert, T. (2023). Prentice Hall Federal Taxation 2023: Corporations,
Partnerships, Estates, and Trusts.
The CPA Journal. (2021, February). Tax treatment of liquidations of partnership interests.
Retrieved from: https://www.cpajournal.com
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.
