Have a Tax Question? Ask a Tax Expert
Thanks you for your question.
What kind of business form do you have? LLC, S,
If LLC is it a partnership (I assume yes), are there other owners?
Are you taxed as a corporation or is it passed thruogh?
ARe you a C corp?
I apologize. I had opted out on this, because I was not able to hang around. this is an extensive question. I am back now. So let me outline this to see if I understand correctly
The partnership had 6 partners.
So your first question was:
Q1: What is my basis in the first buyout of 1&2? The basis is your apportioned share of the price paid to the departing partners. It does not matter what you actually did with the money, whether it was used to pay down a loan or not.
Q2: If the balance on the note is $400,000 at the time of termination do I leave the difference in as basis? The loan is treated separately from the purchase event where you bought out the remaining partners. However, when you consider the expenses of the loan, and the capital gain at the time of your sell (the 75,000), you could end up with a net loss. But you have to treat the capital gains fro the purchase and sell separate.
What is not clear to me, is if the loan of 651,320 was a loan to purchase the original buyout of the first two departing partners. If so then the loan expenses, can be counted as a cost in figuring the capital gains and loses, else not.
Q3: Further more I settled for less than FMV, do I get to count that on schedule D? FMV will not figure into the capital gains formula. The capital gains formula for the shares of number 1 and 2 for the sale would look like this: Capital gains = Sale price - (original cost + cost of sale + management fees if any for the shares).
So for you this means two primary calculation for schedule D.
1. Capital gains for the original share of the business before anyone departed And
2. capital gains or losses for the shares you purchased from the 1&2 departing partners.
You have to apportion the selling price accordingly.
So in this instance, you are very likely to have a capital loss.
Q4: Goodwill issue: Goodwill is a troublesome issue. IT only has a tax consequence when an existing business is purchased in its entirety. So I do not know what or why the did this. It sounds irregular. I am not sure what is going on here. In one place you said the money paid to number one was applied to a note, and now it is good will. Your question is confusing on this issue. If I pay someone 600,000 for shares, that money is leaving the company. So how can it be retained for good will? Teh only way I can see a debt instrument coming to play, is if the partners signed a loan and actually borrowed the 600,000 from the company? So if I go one step further, I could say the company would forgive the debt an and the owners would book good will?
What portion of the good will is your's?
Q1: Your percentage understanding is correct. To understand in dollars and cents. I owned 11.25% before the buyout of the two partners and after I owned 29.80%. So the formula I used is 29.80 x 821,320=$244,753.36 If I understand you correctly, it doesn't matter at this point where the funds came from? This is my thinking. We used funds from the business previous profits to purchase #2 for $170,000, we signed a recourse loan for the full amount purchased from #1 for the 651,320. I thought this was important because I have to add back my release of liability on all recourse loans as part of my purchase price for my shares.
Q2: Again in dollars and cents. Basis of # XXXXX shares is based on a loan but you say the loan can be for anything not just to purchase shares, it is just the fact we have recourse loans to consider in our basis. In fact, we got a new bank at the time we redeemed the two partners shares. Our recourse loans totaled $4,819,965 and when we got out the recourse loans were paid down to 3,332,803. The answer to your questions is yes, regarding the 651,320 we borrowed 100% of the money to pay partner # XXXXX So what you are saying is the basis I have left is 29.80 x the difference between the two numbers minus the interest expense.
Besides the recourse loans we also had retained earnings from previous years to add to our basis. formula would look like this (retained earnings+ reduction in recourse basis-recourse expense) (we have also taken into consideration our 1231 and 179
Q3: FMV Schd D Loss. To purchase the business 100%of the monies were borrowed from the bank. $2,650,000 on recourse. In the beginning we owned 10.75 and two junior parnters got out and our percentage increased to 11.25 a yr before the 61.25% redeemption wich changed our percentage to 29.80% During this time we also purchased our building for $650,000 which had a FMV of 1,320,000 at the time we sold out and in fact was sold for that amount immediately after we departed. You are probably wondering at this point why we sold for so little money. We had to save the business. #1 partner had the deep pockets and when he left we got out of formula to the bank and we had to sign forebearance so we sold outright to another deep pocket investor and he later split the business up. Realestate for 1,320,000. equipment was sold to a lease management co and leased back to the business and the business is an enity unto itself now. Our problem was we had to much short term debt or monthly payments were over $100,000 and after forebearnce no one would touch us.
That is why the price we got out for was a fire sale. Based on IRS rules FMV is based on if you didn't have to sell or the other person didn't have to buy and this wasn't the case for us. I remained as an employee but forgave my ownership to save jobs for 100 people and their families. I am still employed their.
Does fMV have anything to do with our basis?
Q4: When #1 partner got out for 651,320 he stated in his buyout agreement that what he was being bought out for was goodwill and had nothing to do with the underlying real assets so to avoid taxes at a higher level. So our tax financials have this huge # XXXXX goodwill. Maybe this doesn't affect me but I am having to pay on the difference of the building value and recapturing depreciation because their CPA is contributing the increased value of the business to the building although we have an appraisal with a garaunteed purchase price on it for the equipment for much more than what is stated as tax value. This area doesn't concern me as much as getting my basis correct. But i would like to recapture and the loss I had on D for furture years.
My Goodwill portion would be 29.80%
First lets look at FMV as it applies to cost basis.
When you sell ro buy a business, either as an asset sale or entity sales (shares), the price has to be allocated between the assets. You and the buyer can agree to just about any allocation, you like, generally based on FMV. This is valid as long as the IRS does not contest it. (and they generally do not unless the FMV's are far off). REFERENCE: publicaiton 551, Basis of Assets, page 4. http://www.irs.gov/pub/irs-pdf/p551.pdf
So fair market value, as agreed to between you and the buyers is the cost basis for the shares or assets of the business.
For the seller: The apportioned sale price determined by FMV is the value you use to determine gain, loss and recapture.
For the buyer: the apportioned purchase price (sell price) determined by FMVis the cost basis for them to begin depreciation and and any gain or loss during future such transactions.
Okay, I am with you on the subject of FMV.
The partnerships accountant is saying we have no basis in the buyouts and therefore we end up with a negative basis. First she said we only had 13% of the basis and then she said we did own 29.80 of the company but we had no basis for our ownership not even recourse but she wants to count the debt relief against us. She was trying give the basis % to the parnters remaining in the company by taking it away from us. When #1 and #2 sold out our partnership agreement was amended showing our 29.80 ownership and when we sold out our sales agreement we sold 29.80 interest so show can we have no basis if the money came from the company to buy the shares via loans or retained earnings?
Ok so now some of this may beginning to make since to me.
The only way I can see your basis being adjusted to zero, is if there was forgiven debt involved. If you owned a share of that debt to the company for the non-recourse loan, and you still owed on it, after selling your shares, the company will want to make an adjustment in return for debt forgiveness.
is this what happened?
It is my understanding that part of your basis is calculated on the debt you have signed recourse for. You have borrowed money for the business. Each year your basis is adjusted on the amount of recourse you still owe. When you leave the business you are released from recourse loans and that release of recourse is applied taken away from your basis because it was added to you when you signed the recourse. The new owners assumed our place on the recourse loans. The balance on the last recourse loans we at a lessor balance because we had paid on them for 14 mos. One of the loans was a line of credit which had an available balance of 1,500,000 but was at less than 500,000 owed when we got out. This is how I see it..during the 8 years in business we had basis in the begining as we signed a loan for 10.75% of 2.65 mil then througout the course of the partnership we redeemed various partners shares and signed new recourse loans. To make this easy I didn't tell you about the 2 junior partners we bought out in 2004.
Starting basis $284,875 in 1999 based on 10.75%
2004 bought out two junior partners for a total of 30,000 x11.25% basis
2005 bought out 61.25 % for $821,320 x 29.80 basis =244,753
signed new recourse loan in 2005 Adjusted our basis to that 4. some million I referenced earlier x our 29.80
2/28/207 sold out to outside investors 29.80 % for $75,000 cash
So according to publication 550 (I think that is the right #) I get my recourse for basis, but when I get out I have to subtract the current balance on my recourse debt . In my case the balance I owned on recourse was less than what I orginally borrowed. Do I simply forget about the shares and simply look to my recouse loans and retained earings to establish my basis based on my percentage of the business I owned at the time? It took profits to pay down the debt and those profit we created during my ownership. I hope this makes more sense. I know it is somewhat confusing but I will hang in there until it is clear. Thanks I know you can make me understand. bjw
That is correct. that is where I was going next.
without talking to your CPA, or accountant, I can not determine for sure that is what they did..
you did say: "....but we had no basis for our ownership not even recourse but she wants to count the debt relief against us." Which leads me to bleive that is what was done. But I am not sure they handled it correctly, especially in terms of the good will treatment.
If you had 28 + percent of company ownership, there would be a basis for you, except that the basis can be adjusted for debt.
Perhaps she is using the amortization of the good will to reduce your basis as well.
You mentioned earlier if the transfer of certain assets to good will was a tax saving strategy. If you seperate corporate assets from good will, you can exclude the good will portion from the sell, and save about 25% or so on taxes.
Right now without knowing from hte accountant side what his or her thining really was, is pure speculation.
You have certain rights with regard to the selling of your shares. You are entitled to full disclosure. The seller, and buyer, and in this case the partners, must agree on these issues, else you have a basis for cause of action.
I agree with your assessment.
Regarding my tax advocacy status. I am on the citizens Tax Advocacy Panel (TAP) appointed by the secretary of the treasury. We take your individual issues related to the IRS tax process and procedures, and as a panel we evaluate them to determine if it is a systemic problem or an individual problem. If it is systemic, we work with the IRS to improve the process and procedures. If it is determined that an individual issue is isolated to that particular circumstance, then we refer the person to the Local Tax Payer advocate. But this is for issues with the IRS.
For issues with what an employer or business partner is doing you have the following options:
1. report it to the fraud line. The IRS will investigate.
2. File your taxes in the manner you think they should, and use a cover letter indicating why the discrepancies. The IRS will investigate before allowing your claims.
3. hire a tax attorney to file cause of action against the partners.
You can use any of these alone, in combination or all together.
The IRS fraud reporting contact is: http://www.irs.gov/individuals/article/0,,id=106778,00.html