Hello, everyone. You should have received two emails, one
from Wanda and one from Pam requesting substantial
withdrawals. Below is a good explanation for the options
available for the club to disperse these requests. It is a
complicated situation to transfer stock, but we must
consider it due to the lack of cash and stocks to sell at a
loss. Please review this carefully so we can all be on the
same page at the August meeting. I am available for
questions, but will be out of town until July 1st.

Thanks,
Linda

Jerry A. Dressel on 07/21/2000
The tax implications of a partial withdrawal can be more
complex than for a complete withdrawal, depending upon how
the member is paid and the source of cash funds that are
used. 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 or 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 partial withdrawal of
the withdrawing member. Total withdrawals have different
IRS rules.

In simple terms, stock transferred in a partial withdrawal
has a cost basis equal to the club's cost basis in that
stock when it is transferred to the withdrawing member.
However, this cost basis may not exceed the withdrawing
member's cost basis in the club, reduced by any cash also
distributed in the withdrawal. It is important to note that
if more than one stock, or even multiple blocks of the same
stock, are transferred, the allocation of cost basis between
these stocks is quite complex. IRS Publication 541 details
this allocation process, and bivio handles the calculations
without any problem.

As a comparison, stock transferred in a complete withdrawal
has a cost basis equal to the member's cost basis in the
club, (not the stock's cost basis) reduced by the amount of
any cash distributed in the withdrawal.

Let's compare 5 alternatives for partial withdrawals.

A member makes a partial withdrawal and is paid out with
cash on hand.
Effect on the Withdrawing Member: The withdrawing member's
cost basis in the club is reduced by the amount of the
withdrawal, down to, but not below, zero. If the withdrawal
amount exceeds their cost basis in the club, they must treat
the excess as a capital gain in the year in which the
withdrawal is made.

Effect on the other members: none

The club sells stock that it holds at a gain to raise cash
for the member making the partial withdrawal.
All members, including the withdrawing member, realize their
pro-rata share of the gain on this sale of stock. See Tax
Allocation Methods for more information.

Effect on the withdrawing member: The withdrawing member
also realizes a gain upon withdrawal if the cash withdrawn
exceeds their cost basis in the club.

Effect on the other members: PROBABLY NOT SO GOOD! Everyone
pays capital gains taxes this year.

The club sells stock that it holds at a loss to raise cash
for the member making the partial withdrawal.
All members, including the withdrawing member, realize their
pro-rata share of the loss on this sale of stock. See Tax
Allocation Methods for more information.

Effect on the withdrawing member: The withdrawing member
realizes an additional taxable capital gain upon withdrawal
if the cash withdrawn exceeds their cost basis in the club.

Effect on the other members: PROBABLY GOOD! (From a tax
standpoint, anyway.) Everyone writes off a capital loss this
year.

Effect on the club: An under-performing stock is removed
from the portfolio. However, just because the stock has
under-performed doesn't necessarily mean that it doesn't
have potential.

The club issues appreciated stock to the member making the
partial withdrawal.
Effect on the withdrawing member: The withdrawing member's
cost basis in the transferred stock is equal to the club's
cost basis in that stock when it is transferred to the
withdrawing member. However, this cost basis must be
adjusted so that it doesn't exceed the withdrawing member's
cost basis in the club, reduced by the amount of any cash
also distributed in the withdrawal.

If the club's cost basis in the transferred stock plus cash
is less than the withdrawing member's cost basis in the
club, the transfer of appreciated stock may cause the
withdrawing member to realize a larger gain upon the sale of
the stock than if the withdrawing member received cash.

On the other hand, if the club's cost basis in the
transferred stock plus cash is more then the withdrawing
member's cost basis in the club, the withdrawing member will
realize the same gain as if they had received a cash payout.
However, that gain is deferred until the stock is sold.

The cost basis of the transferred stock, plus any cash that
is distributed, reduces the withdrawing member's remaining
cost basis in the club, but it is not reduced below zero.

Effect on the other members: No current gain is realized.
The difference between each member's cost basis and their
capital account value in the club will be their gain or loss
upon withdrawal.

Q: Will the other members incur a large or disproportionate
amount of deferred capital gains taxes?
A: No. The only gain or loss the other members will have
when they withdraw is the difference between their cost
basis in the club and the current value of their account
when they withdraw.
Effect on the club: PROBABLY GOOD! The Club transfers a
stock that it holds at a gain without the other members
realizing a capital gain. This assumes that the club is
willing to part with the stock anyway. The club can
repurchase the stock at a new cost basis if it still likes
the stock.

The club transfers stock it holds at a loss to the member
making the partial withdrawal.
Effect on the withdrawing member: The withdrawing member's
cost basis in the transferred stock is equal to the club's
cost basis in that stock when it is transferred to the
withdrawing member. However, this cost basis must be
adjusted so that it doesn't exceed the withdrawing member's
cost basis in the club, reduced by the amount of any cash
also distributed in the withdrawal.

If the club's cost basis in the transferred stock plus cash
is less than the withdrawing member's cost basis in the
club, the transfer of stock held by the club at a loss will
cause the withdrawing member to realize a capital loss upon
the sale of the stock. On the other hand, if the club's cost
basis in the transferred stock plus cash is more than the
withdrawing member's cost basis in the club, the transfer of
stock held by the club at a loss allows the member making
the withdrawal to postpone the gain on the distributed
dollar amount that exceeds their cost basis in the club
until the stock is sold.

Effect on the other members: No current loss is realized.

Effect on the club: PROBABLY NOT GOOD! The Club transfers a
stock that it holds at a loss without the other members
realizing any current loss. If the club wants to get rid of
the stock anyway, it is better to sell it so everyone writes
off a current loss. Issue cash to the withdrawing member.

Considerations
Remember.... In the long run, varying payout methods only
impacts WHEN gains or losses are realized. Postponing or
deferring taxes, to the extent that the IRS allows and to
the extent that it is prudent within the management of your
club portfolio, can have significant advantages in your
long-term investment strategy. The payout method will NOT
impact the overall cumulative total of the gains or losses
realized by a club member.

The tax treatment of partial withdrawals is complex. Many
factors must be considered: the amount of cash distributed,
the club's cost basis in the transferred securities, and the
cost basis of the member making the partial withdrawal.

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