Reference no: EM13541651
Ben Grimm is a 40% partner in We Four, LLC a super-heroing service organization reporting on a calendar year on the cash basis. (He does most of the heavy lifting). Reed Richards has 40%, he is the brains. Sue Richards has 10%--they never see her doing anything. Her brother Johnny Storm has the other 10%. Ben decides to retire.
The LLC is on a calendar year. At the end of 2013, the balance sheet read as follows:
Assets Basis FMV
Cash $ 100,000 $ 100,000
A/R -0- 180,000
Inventory* 30,000 50,000
Patents** 20,000 125,000
Equipment 75,000 95,000
Total Assets $225,000 $ 550,000
*We Four used to sell rebuilt super equipment to new super heroes but this never took off. This is the remaining inventory they are selling off at a discount. Now they are a purely service agency.
**Some they bought from Stark Industries, thus the basis, some Reed invented. For this purpose, these are not hot assets.
Debts Basis FMV
Notes Payable $ 100,000 $100,000
A/P $ -0- $ 80,000
Total Debt $ 100,000 $180,000
Capital Accounts Basis FMV
Reed Richards $ 50,000 $148,000
Ben Grimm $ 50,000 $148,000
Susan Richards $ 12,500 $ 37,000
Johnny Storm $ 12,500 $ 37,000
Total Equity $125,000 $370,000
Total Debt & Equity $225,000 $550,000
The LLC is anticipating a total net profit for the year of $160,000 of which $90,000 (prior to payment of old A/P) was generated as of June 30, 2014-as if the books were closed as of that date. As of that date, the LLC had paid down it's A/P by $40,000 but had increased its Notes Payable by $60,000. With Ben taking it easy (he was the collection department) A/R have increased by $20,000. Cash increased by $50,000 ($90,000 {profit} + $60,000 {additional Note Payable} - $40,000 {payment on A/P} - $60,000 {additional equipment}. The borrowed funds were invested in a new Skrull detection system and a subterranean tracking system to monitor the Mole man (again, I don't write this). Other assets are the same. There have been no distributions during the year.
Ben wants to retire effective as of the June 30, 2014 date.
His outside basis as of December 31, 2013 was his capital account basis plus his share of liabilities. The LLC has agreed to pay him the sum of $ 250,000 in liquidation of his interest. We Four does not have sufficient cash available for this so has offered to pay him in 4 installments of $62,500 each. The first installment will be paid on December 1, 2014, and the remaining installments on the 1st day of July of each succeeding year.
I. On the first meeting:
a. Ben wants to know how he will be taxed?
b. Reed wants to know how the LLC should account for 2014 income, and what effect these payments will have on the LLC return. Yes, you asked and they can't find an operating agreement (the equivalent of a partnership agreement). How do they report this each year?
II. On your second meeting:
a. Reed remembered that he had secured a copy of the partnership agreement in an alternate universe where story lines are logical. It does contain a provision requiring the LLC to pay a retiring partner his or her share of goodwill.
b. How does this change the picture? It does not state how to allocate payments. They have agreed to let Ben decide how to allocate this year's income---within the rules?
III. Ben likes to tinker and may take the inventory as part of his payment this year. He hasn't decided but asks:
a. What if he opens an equipment shop down on Yancey Street and uses this as his opening inventory?
b. What if he just builds himself a personal limousine?
c. How will his decision affect his tax picture and that of the LLC?
IV. Reed calls. He wants to know if there are any planning opportunities the LLC should consider as part of this buy-out?
Hints:
1. You may want to adjust the balance sheet as of 6/30/2014 to see what happens.
2. Determine what is ordinary income and capital gain/loss for Ben and how would that change under the options he and Reed suggest?
3. What is an income payment or capital payment for the LLC?
4. What could the LLC deduct and how would they structure it to do so?
5. After the buy-out, what elections might the LLC want to make and why or why not?