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cost basis in the club and the cash withdrawn.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basis in the club and the cash withdrawn.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cost basis in the club and the cash withdrawn.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