Member Withdrawals - payout options for your club.
Jerry A. Dressel on 07/21/2000
Clubs often may have more options available to them in
paying a withdrawing member than they first realize. The
initial reaction of most clubs is to sell stock, increase
member payments, or simply use cash on hand to come up with
enough cash to pay off a withdrawing member. This may not,
however, be the most advantageous method from a tax
perspective. IRS Publication #541 - Partnerships
defines the rules pertaining to distributions to withdrawing
members. In accordance with that publication, let's look
at the options available to your club and the withdrawing
member. But first, it must be noted that this document is
assuming a total withdrawal for the withdrawing member.
Partial withdrawals have different IRS rules.

From a tax standpoint, let's assume......


    The club pays withdrawing members with cash on hand.

    The source of this cash can be from existing cash on
    hand or additional payments by the remaining members.
    Members who withdraw realize a gain or loss upon
    withdrawal. The gain or loss is based on the difference
    between their cost basis in the club and the cash
    withdrawn.

    This method has no effect on remaining members. NOT
    GOOD, NOT BAD. The club and the withdrawing member may
    be better off from a tax standpoint by distributing
    appreciated stock to a withdrawing member.

    The club pays withdrawing members with cash received
    from the sale of appreciated stock.

    All members, including members who are withdrawing,
    realize their pro-rata share of the gain on the sale of
    the stock. See Tax Allocation Methods for more
    information. In addition, the withdrawing members
    realize a gain or loss that is based on the difference
    between their cost basis in the club and the cash
    withdrawn.

    The effect on club members: everybody pays capital gains
    taxes. PROBABLY NOT SO GOOD!

    The club pays withdrawing members with cash received
    from stock that was sold at a loss.

    All members, including members who are withdrawing,
    realize their pro-rata share of the loss on the sale of
    the stock. In addition, the withdrawing members realize
    a gain or loss that is based on the difference between
    their cost basis in the club and the cash withdrawn.

    The effect on club members: everyone writes off a
    capital loss. PROBABLY GOOD...from a tax standpoint
    anyway.

    The club pays withdrawing members by transferring
    appreciated stock to them.

    The withdrawing members' cost basis in the transferred
    stock equals their cost basis in the club. Withdrawing
    members do not realize a gain until they sell the stock.
    The remaining members do not realize a current gain.
    When remaining members withdraw, they will realize a
    gain or loss based upon the difference between their
    cost basis and the current value of their account in the
    club.

    The effect on club members: the remaining members do not
    realize a current gain from the transfer of an
    appreciated stock. PROBABLY GOOD. If the club wants to
    continue to own this stock, the club may immediately
    repurchase the stock at a new cost basis. The wash sale
    rule does not apply in this situation.

    The club pays withdrawing members by transferring stock
    the club holds at a loss.

    The withdrawing members' cost basis in the transferred
    stock equals their cost basis in the club. Withdrawing
    members do not realize a gain or loss until they sell
    the stock. The remaining members do not realize a
    current loss. When remaining members withdraw, they will
    realize a gain or loss based upon the difference between
    their cost basis and the current value of their account
    in the club.

    The effect on club members: the club transfers a stock
    that it holds at a loss without the remaining members
    realizing a current loss. PROBABLY NOT GOOD! If the club
    wants to eliminate the stock, the better option is to
    sell it. The current members write off a current loss
    and cash can be issued to the withdrawing member.

Once again, it's important to always use IRS Publication
#541 as your official source of information pertaining to
these issues and your club as a partnership.

Jerry Dressel
St.Louis, Missouri
Trez_Talk@bivio.com