Entrepreneur Start-Up Series: Part 3 – Ending a Partnership
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Are your partnership days numbered? For many new start-ups, shifting partnerships are quite common. How and when you or one or more or your partners choose to end the relationship can have distinctly different tax consequences.
Before you sign an agreement, consider the following:
Distribution of interest. Classification and taxing varies, depending on the amount of interest the selling partner has in the partnership’s capital and profits. If a partnership is dissolved, the partnership is liquidated and taxed as such. However, if the partnership is terminated and the interest of the selling partner equals 50% or more of the partnership’s capital and profits, then special rules apply.
Timing of the sale. Depending on the taxable year utilized by your partnership and your taxable year, a termination could potentially bunch up to 23 months of partnership income into a single taxable year, effectively doubling the amount of income that you would normally pay tax on.
Tax elections. Although termination of the partnership may cause the loss of a favorable depreciation schedule for the partnership’s assets, it does create an opportunity to make new tax elections, which would normally require IRS consent.
In general, when a partnership terminates for federal income tax purposes due to a sale of 50% or more interest in the partnership, two things happen: (1) the new partnership inherits all of the old partnership’s assets and liabilities, and (2) the old partnership distributes interests in the new partnership to the remaining partner and the new partner.
In addition, if you are the remaining partner, the termination of the old partnership and the formation of the new partnership should have no tax consequences for you. There will be no recognition of gain upon the contribution of assets from the old to the new.
Ending a partnership can be emotionally and financially complicated. I have numerous years of experience helping business professionals like you navigate the legal issues involving partnerships. Together, we can determine the right choices for you and I welcome the opportunity to meet with you to evaluate your personal situation.