club_cafe: Unrealized Long Term gains, Member Withdrawl, and double taxat

iras1 on

In a message dated 4/5/2006 1:53:13 P.M. Eastern Standard Time, colacurcio@bivio.com writes:

Well, the subject says it all.

We've got a slew of unrealized long term gains.
We've also got a few members leaving.

Now, I've seen the withdrawl report and how they will be
responsible for their gains on a Schedule-D.

The question I've got is how can we account for those taxes
being paid (within the club) so that when we finally do sell
those securities, we can recognize that some of the
long-term capital gains taxes have already been paid, and
not pay it again.

Huh?

Seriously, you don't have to do anything. When a member leaves and you prepare their withdrawal statement, they will pay capital gains on their share of the increase in the value of the club during the period they were members. If you pay them off in cash, they will be responsible for the capital gains "now" (tax year 2006). If you pay them off in appreciated stock, they can choose the tax timing. When the club sells stock, any realized gain is allocated to the members at that time and the amount of allocated gain reduces the amount of gain that specific member will report when s/he withdraws from the club. So, there's never more or less tax to pay... it's only a question of when the tax is paid.

Ira Smilovitz

Rip West on

Ira said.....

<<

So, there's never more or less tax to pay... it's only a question of when the tax is paid.

>>

That is true, as far as it goes, but it is not the complete story. If you pay off members with cash while you have appreciated stocks in your portfolio, you are almost certainly going to be paying taxes ahead of the time that is necessary. The best way to handle the situation is to transfer appreciated stocks to the withdrawing members. Those members will be no worse off, and, indeed, can now time the payment of their tax, since it won't have to be paid until the stock is sold.

If you use cash, you will be paying more tax than necessary when and if you sell those appreciated stocks. The reason for this is that the gain on the stocks will be spread among the remaining member, including the gain attributable to those members who have left.

In short, there is no downside to using appreciated stocks for the payoff, and all sorts of upside.

Rip West
Saint Paul, MN

Patrick Colacurcio on

Thanks Rip & Ira, but I'm still not seeing the light.

If we pay out in cash, and then, later, we sell appreciated
stock
A) The paid-out member needs to declare their capital gains
in a schedule d
and
B) We need to handle the capital gains of the appreciated
stock in our K-1's.

In this scenario, the tax burden on both the remaining
members (who pay the capital gains on the sold security) and
the member who left (who also pays capital gains on the
unrealized gain of the security).

So, those gains are, in effect, being taxed twice.
Once on the leaving member, and once when the security is
actually sold.

This seems strange. Is there a flaw in my reasoning here?

In the scenario that Ira mentioned, we could give them
securities, but that seems to have a whole other slew of tax
implications associated with it. What's the new basis cost
of the security? Is the leaving member then solely
responsible for the taxes on that security?

Our club prefers to deal with cash. I'm just wanting to see
if there's a way to not pay gains taxes twice on unrealized
securities.

Thanks,
-Mezz

Rip West wrote:
> Ira said.....
> �
> <<
> So, there's never more or less tax to pay... it's only a
> question of when the tax is paid.
> >>
> �
> That is true, as far as it goes, but it is not the complete
> story. If you pay off members with cash while you have appreciated stocks in
> your portfolio, you are almost certainly going to be paying taxes ahead of the
> time that is necessary. The best way to handle the situation is to transfer
> appreciated stocks to the withdrawing members. Those members will be no worse
> off, and, indeed, can now time the payment of their tax, since it won't have to
> be paid until the stock is sold.
> �
> If you use cash, you will be paying more tax than necessary
> when and if you sell those appreciated stocks. The reason for this is that the
> gain on the stocks will be spread among the remaining member, including the gain
> attributable to those members who have left.
> �
> In short, there is no downside to using appreciated stocks for
> the payoff, and all sorts of upside.
> �
> Rip West
> Saint Paul, MN
> �

Patrick Colacurcio on

Thanks Rip & Ira, but I'm still not seeing the light.

If we pay out in cash, and then, later, we sell appreciated
stock
A) The paid-out member needs to declare their capital gains
in a schedule d
and
B) We need to handle the capital gains of the appreciated
stock in our K-1's.

In this scenario, the tax burden on both the remaining
members (who pay the capital gains on the sold security) and
the member who left (who also pays capital gains on the
unrealized gain of the security).

So, those gains are, in effect, being taxed twice.
Once on the leaving member, and once when the security is
actually sold.

This seems strange. Is there a flaw in my reasoning here?

In the scenario that Ira mentioned, we could give them
securities, but that seems to have a whole other slew of tax
implications associated with it. What's the new basis cost
of the security? Is the leaving member then solely
responsible for the taxes on that security?

Our club prefers to deal with cash. I'm just wanting to see
if there's a way to not pay gains taxes twice on unrealized
securities.

Thanks,
-Mezz

Rip West wrote:
> Ira said.....
> �
> <<
> So, there's never more or less tax to pay... it's only a
> question of when the tax is paid.
> >>
> �
> That is true, as far as it goes, but it is not the complete
> story. If you pay off members with cash while you have appreciated stocks in
> your portfolio, you are almost certainly going to be paying taxes ahead of the
> time that is necessary. The best way to handle the situation is to transfer
> appreciated stocks to the withdrawing members. Those members will be no worse
> off, and, indeed, can now time the payment of their tax, since it won't have to
> be paid until the stock is sold.
> �
> If you use cash, you will be paying more tax than necessary
> when and if you sell those appreciated stocks. The reason for this is that the
> gain on the stocks will be spread among the remaining member, including the gain
> attributable to those members who have left.
> �
> In short, there is no downside to using appreciated stocks for
> the payoff, and all sorts of upside.
> �
> Rip West
> Saint Paul, MN
> �

Gene Rooks on

Hi, you've gotten the good advice from the experts, let me see if I can put
it in simpler language. If you pay your member in cash, whatever you buy
or sell after that doesn't affect him at all, it all falls on your members.
So, if you sell an appreciated stock after his withdrawal, all of you share
in your proportion of the capital gain that year.

However, if you transfer the appreciated stock to him, his tax basis in that
stock is based, not on what you paid for it, but on the difference between
that stocks value, less any cash he gets, (hope I stated that right), and
less what his PIPE/tax basis is in the club. The gain that stock had
between the time you bought it and the time you transferred it to him is not
passed on to your members until each one withdraws themself, and they only
are taxed on their percentage share of it. There is no double taxation to
anyone, ever. You are simply deferring payment of tax on the capital gain.

I hope that helps, Gene

Rip West on

<<

If we pay out in cash, and then, later, we sell appreciated stock
A) The paid-out member needs to declare their capital gains in a schedule d and
B) We need to handle the capital gains of the appreciated stock in our K-1's.

In this scenario, the tax burden on both the remaining members (who pay the capital gains on the sold security) and the member who left (who also pays capital gains on the unrealized gain of the security).
>>

Yes, indeed. In that scenario, taxes have been paid twice on the appreciated stock. That injustice will be rectified as each remaining member leaves the club, since the additional income is added to each member's tax basis, which event will reflect in lower gains as they leave the club. That's why it is NOT a good idea to pay for withdrawals in cash.

<<

In the scenario that Ira mentioned, we could give them securities, but that seems to have a whole other slew of tax implications associated with it. What's the new basis cost of the security? Is the leaving member then solely responsible for the taxes on that security?
>>

The 'whole other slew of tax implications' are all good implications. The member's cost basis for the stock received will be his tax basis for the partnership interest, less any cash received. If he sells the stock right away, he will be paying exactly the same tax that he would have paid if he had taken cash. He has the added benefit of being able to defer the tax until such time as he actually sells the stock. In the meantime, the appreciated stock is removed from the portfolio, so remaining members do not have to pay tax on that stock when it is sold. This has the effect of deferring taxes for the remaining members.

<<Our club prefers to deal with cash. >>

That's fine, as long as you understand that they are also preferring to to pay taxes in advance [or, in your words, be subject to double tax].

<<

I'm just wanting to see if there's a way to not pay gains taxes twice on unrealized securities.
>>

As stated before, no one is paying taxes twice. If you use cash for withdrawals you taxes are being paid twice, but will eventually be offset as the members leave. It's more accurate to say that taxes are being prepaid, or being paid before it it necessary. Payming members with appreciated stock will correct that situation.

Rip West
Saint Paul, MN