When two or more people form a business partnership, each contributes personal assets and cash for the benefit of the new company. At tax time, each partner reports a percentage of the company earnings on his or her personal tax return that matches the percentage of investment. If the partnership makes liquidating distributions, it only has tax consequences for the partner who receives them. However, the Internal Revenue Service (IRS) requires the partner making liquidating distributions to terminate his or her partnership arrangement with the business first.
How a Partner Reports a Gain or Loss
The partner who receives a liquidating cash distribution may have a taxable gain or loss to report. The IRS treats decreases to the partner’s share of debt and the value assigned to marketable securities as cash distributions. When the amount of distributed cash exceeds the partnership interest of the receiving party, the difference between the amounts counts as a gain.
A loss occurs when the amount a partner receives as a liquidating distribution is lower than the partner’s investment in the company. The IRS only allows people in business partnership agreements to report a loss if it occurred due to inventory items, outstanding partnership receivables, or a liquidating cash distribution.
The Effect of Liquidating Partnership on Property
The liquidating partner has no tax impact if he or she distributes property during the liquidation period. That is because calculating gain or loss doesn’t occur until the partner sells the property. Assuming the liquidation terminates any interest the partner has in the property, the tax paid on the sold property is equal to the partner’s interest in the business less cash already distributed to him or her. The partner’s interest in the property is never less than zero, regardless of how much cash he or she receives.
Ownership Percentages Can Change Over Time
Before a partner can determine the tax impact of the liquidation, he or she will need to sit down with an accountant to figure out the current personal tax basis from the partnership. The amount may be significantly more or less than the partner contributed to the partnership when forming it. It’s necessary to consider whether personal contributions to the business partnership increased or decreased throughout the years as well as the percentage of losses or deductions.
Tax Implications for the Buyer of the Partner’s Interest
The buyer in this type of arrangement inherits a capital account from the seller. This typically shows a disparity since the seller’s business assets may have increased or decreased. IRS Code § 754 allows buyers to make a one-time adjustment to account for this difference.
Are You Considering Liquidating Partnership?
Tax implications from any business transaction can be complex, and this is no exception. Please don’t hesitate to schedule a consultation with KGBV Advisors to learn more about tax and other consequences of liquidating your business partnership.