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jameshr
07-22-2010, 09:39 AM
I (Sole Proprietor) may receive a large payment as the result of the buyout of a company I contracted with heavily over the years. The owner is paying me in part as a Thank You for much hard work over the years to help get the company to this point and part incentive for my cooperation going forward with the buyer during the coming years since I know so much about the product. The owner is very flexible on how this payment will occur.

What is the best way to setup and receive this payment to minimize tax exposure for 2010? For example, could the owner grant me LLC membership just prior to the sale in order to classify this payment as a Capital Gain no my taxes. Please give me some options and thanks in advance for your insight. We are probably 30-60 days away from the buyout event.

Evan
07-22-2010, 10:09 AM
Not sure what you're trying to gain by having ownership in the LLC.

If you're receiving this payment as a buy out of your businesses assets, you should be having capital gain treatment to the extent the payment is for assets (including any self-made goodwill).

jameshr
07-22-2010, 10:38 AM
Evan, thanks so much for feedback. The buyout is not of my company...the buyout is scheduled soon for another LLC which I only contracted with and have no shares (membership). But, the single owner of the LLC wished to share in his good fortune of this sale.

So, I was wondering if the owner could assign me membership withing this next 30-60 days so that the eventual payment would be treated as income on my new assets (Capital Gains) rather than regular income.

As I understand it for 2010, such an asset owned 12 months or less is subject to my regular income tax rate for 2010. I assume that means if I earned say $80k of regular income for 2010 and the tax table registered say 20% rate...then I would also use 20% as the rate on this buyout deal. Otherwise, if I do nothing I am looking at a much higher rate.

Does that make any sense or is there another approach?

Evan
07-22-2010, 03:53 PM
If you have a membership interest, aside from just a capital gain, you'll also have a percentage of profits and losses allocated to you -- that is also ordinary income.

I am confused with this situation. You're seeking a membership interest in the business ACQUIRING the assets? Or selling the assets? If they're acquiring the assets, you'd have no capital gain treatment. Essentially, they're buying the assets of the other business, so cash will go down, and assets will increase -- that isn't a taxable event.

If you're on the other side of the transaction, there would be a capital gain event going on -- but a lot of these details would need to be in the Operating Agreement with how to allocate this portion to you.

In any event, it looks like you're receiving a commission, which is ordinary income to you.

ArcSine
07-22-2010, 05:08 PM
James, I have to agree with Evan that you've got a number of hurdles to overcome, some of which may be insurmountable if your objective is to have your share of the buyout characterized as LTCG. Maybe the best advice I can offer here is to say that on this one you're dancing with a pretty complex section of the tax law, and in such cases it's usually wise to lay everything out on a tax pro's desk and let him or her do some research for you.

That said, though, I still have a few cryptic notes from a deal I was involved in about a year ago, which actually shared some common ground with yours. For one, your first hurdle would be to have the equity that's transferred to you "pre-buyout" be considered a profits-only interest, rather than a capital interest. The importance is that a capital interest, having been transferred to you in exchange for personal services, would be immediately taxable to you at its fair value, and it'd be ordinary. The fly in that ointment is that in order to not be considered a capital interest, it must entitle you to only share in any appreciation that occurs after the date it's transferred to you. If you could convince an IRS agent that all of the company's value-uptick occured in those last 20 or days prior to the buyout, you're a better man than I!

Beyond that, if you were successful in having the equity treated as a capital asset in your hands, then it'd become a capital asset for which your holding period was only 20 - 30 days or so. Hence, short-term cap gain treatment.

There's also the very real risk of the IRS asserting that regardless of how you've structured it on paper, the facts and circumstances of the transfer (and esp. its timing w.r.t. the impending buyout) makes it undeniably a form of compensation for personal services.

(As a footnote of sorts, you might wanna check out Rev. Proc. 93-27 and Rev. Proc. 2001-43 for more thrilling details.)

Nevertheless, refer back to my first bit o' advice. There may be a way for you receive a package of options, say, exercisable at later benchmark dates, that provide certain planning ops. But that kinda stuff requires some face-to-face with a tax guru.

Best of luck with the deal, and congrats!