Paying Withdrawing Member

Lois J Petersen on

I know this has been discussed (maybe endlessly) and I have
a BI article from February 2006, "Handling Member
Departures" paragraph 4 but particularly the red, yellow and
green chart.

The last "green" item, Pay withdrawing members by
transferring appreciated stock to them indicates the Tax
Effect on Club: "The remaining members don't realize a
current gain from the transfer of an appreciated stock".
The "current gain" part puzzles me...does it mean they never
realize a gain, realize a gain down the road, or does that
just relate to their own particular tax situation? I may
have found the answer for this part from another article.
The gain would be realized by remaining members when they
leave the club, right?

The two "yellow" Solutions make sense, though the 2nd yellow
Tax Effect indicates "potentially" pay capital gains tax.
By "potentially" does it again relate to their own
particular tax situation? And why would you Pay withdrawing
members with cash received from the sale of appreciated
stock unless you had no other choice?

We need to make a decision on May 25 to pay a departing
member and with the market down (since our valuation day),
though it may rebound, we'd appreciate all the help we can
get.

Lois Petersen
Common Interest Growth Club

iras1 on

I'm sure Rip intended for the last word in the quoted sentence to be "cash" and not "stock".

Ira Smilovitz

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In a message dated 05/07/10 14:39:09 Eastern Daylight Time, ripwest@comcast.net writes:

My recommendation is to transfer appreciated stock to the withdrawing member, and this recommendation stands even if you have enough cash on hand to pay off the member or even if you have new members coming in who will provide the stock.

Rip West on

Hi Lois,

The last "green" item, Pay withdrawing members by transferring appreciated stock to them indicates the Tax Effect on Club: "The remaining members don't realize a current gain from the transfer of an appreciated stock". The "current gain" part puzzles me...does it mean they never realize a gain, realize a gain down the road, or does that just relate to their own particular tax situation? I may have found the answer for this part from another article. The gain would be realized by remaining members when they leave the club, right?
>>

That's right. And, as I will talk about later, if you don't use this method, the remaining members could well pay taxes before the need to if other methods are used. Also, not stated in the article is the fact that the withdrawing member avoids paying tax until he/she sells the appreciated stock that was transferred. If cash were used, the tax would be immediate.

And why would you Pay withdrawing members with cash received from the sale of appreciated stock unless you had no other choice?
>>

You would be surprised at how many clubs do just that. You are correct. It makes no sense.

My recommendation is to transfer appreciated stock to the withdrawing member, and this recommendation stands even if you have enough cash on hand to pay off the member or even if you have new members coming in who will provide the stock. The reason is that if you don't use that appreciated stock, when you sell it, the gain will be allocated to the remaining members who are now one less that they were before the withdrawal. In other words, the remaining members will be picking up the gain attributable to the withdrawing member when that stock is sold. These members are thus 'prepaying' their taxes on a subsequent sale of the appreciated stock. They will get this back when they leave the club, but that could be years down the road. The withdrawing member will pay the correct tax when he/she leaves, so when appreciated stock is subsequently sold, the IRS is going to collect more money than they are entitled to for a period of years. To avoid this, transfer appreciated stock.

Rip West
Saint Paul, MN

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