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Lev
Lev, Tax Advisor
Category: Tax
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We are winding down an LLC Parntership....When the LLC partnership

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We are winding down an LLC Parntership....When the LLC partnership was set up the capital % we based on the profit and loss %......but each partner did not contribute according to the capital %. One contributed 0 but still had 20% capital.....one contributed $200,000 more then another but only had 15% where the other had 25%. Now we are trying to wind down the company and there is $300,000 to distrubute. According to the operating agreement we distribute based on capital contributions and withdrawls. Do we go by the capital % we did initially or take the the contributions less withdrawls and divide by the member equity to get the % or by the equity left to distribute.

Lev :

Hi and welcome to our site!
First of all - create a formal agreement that outlines all dissolution terms for your partnership - and have all partners agreed on these terms.
Because - according to the operating agreement we distribute based on capital contributions and withdrawals - it seems that liquidation should be based on partner's basis. .
The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest.
See for reference - http://www.irs.gov/Businesses/Partnerships/Partnership---Audit-Technique-Guide---Chapter-1---Basic-Principles-(Rev.-3-2008)

Lev :

Generally - there are two types of interest - based on the agreement between partners.
The profits interest of a partner is the partner’s distributive share of partnership income.
The beneficial interest is a proportion to the person’s actua­rial interest. The beneficial interest in an unincorpor­ated enterprise, includes any right to receive a share of distribu­tions from the profits of the enterprise, or if there is no profit-sharing agreement, the right to re­ceive a share of the assets on liquidation of the enterprise. When no agreement fixing the rights of the par­ticipants in the enterprise exists, the fraction of the respective interests of each participant in the enterprise will be determined by dividing the total investment or contributions to capital made or obligated to be made by the participant by the amount of all investments and capital contribu­tions made by all participants.

Customer:

The operating agreement states the monies are distribute based upon the capital contributions, the problem is the capital contributions % are wrong. It does not reflect the actual contributions......do the capital % always change when someone contributed more capital...it dilutes the account.....is the right?

Lev :

There is no automatic change. The beneficial interest as mentioned above is based on the agreement between partners. If all partners agree that agreement may be changed.
If there is no agreement - you may use capital accounts at the time of liquidation as the basis to divide assets. But again - all partners must agree.

Customer:

You mean if all parties agree use the Capital % not the actual contribution %.

Lev :

That is correct - if the capital contributions are not correct - you may not use that - but shoudl use the actual contributions.

Customer:

Yes...the capital Contribution % on the books are wrong. So when the operating agreement says to use the Capital contributed as your liquidation distribution we should use the actual capital contribute as the %...so if someone did not contribute anything then they get 0.....correct, even through their capital contribut % on the books says 20%

Lev :

Yes - that is correct. But again - if any partner disagrees - there will be a huge problem.

Customer:

Got it thanks.....

Lev :

So - far - there are two basis rules:
1. If there is a valid agreement in effect fixing the interest rights of the partners in the partnership interest - we need to follow that agreement.
2. When no agreement fixing the rights of the partners exists, the fraction of the respective interests of each participant in the enterprise will be determined by dividing the total investment or contributions to capital made or obligated to be made by the participant by the amount of all investments and capital contributions made by each partner.
3. If some partners are thinking that there is a valid agreement - and some consider that agreement as not valid - there will be a huge problem - that must be resolved before moving forward.

Lev and 4 other Tax Specialists are ready to help you
So - far - there are two basis rules:
1. If there is a valid agreement in effect fixing the interest rights of the partners in the partnership interest - we need to follow that agreement.
2. When no agreement fixing the rights of the partners exists, the fraction of the respective interests of each participant in the enterprise will be determined by dividing the total investment or contributions to capital made or obligated to be made by the participant by the amount of all investments and capital contributions made by each partner.
3. If some partners are thinking that there is a valid agreement - and some consider that agreement as not valid - there will be a huge problem - that must be resolved before moving forward.
Customer: replied 3 years ago.

Here is the twist...we need to go back to the original capital contribution %. So we need to adjust this capital % every year depending up the net income??? Does the capital % change only with contributions at the end of the year....

Yes - partners must keep track of their inside and outside basis which is adjusted EVERY year - not only with additional capital contribution s- but for other items as well.
That is way more complex than tracking capital contribution for corporations.
For instance the IRC section 705(a)(1) provides that the basis of a partner’ partnership interest is increased by his/her distributable share of:
(A) Taxable income
(B) Tax exempt income
(C) Excess of the deductions for depletion over the basis of the property subject to depletion
The IRC section 705(a)(2) provides that a partner’s partnership interest is decreased by distributions provided for in IRC section 733. These distributions are:
(1) the amount of money distributed, and
(2) the partner’s amount of basis in property distributed.
(3) Losses of the partnership;
(4) Nondeductible partnership expenditures which cannot be capitalized;
(5) Depletion.
There might be other adjustment items as well.
Customer: replied 3 years ago.


Sorry with a client.....I have the basis worksheets...just wondering about the capital % if they change each year with the outside basis.....

That is correct.
If the partnership tax return was correctly prepared - that information could be found on schedule K-1.