Who Should Pay the Tax on Members' Withdrawals
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Who Should Pay the Tax on Members' Withdrawals I had a question about member
withdrawal. We have nine members leaving. I understand that when we
sell our stocks to pay off the other members we will incur long term or short
term capital gains taxes. These taxes will be split among all of our
members. Other club members feel that these taxes are the responsibility
of the people leaving because we are selling our stocks specifically for
them. What is the correct way to handle
this?
This question comes up often. It is true that the members who
are leaving are triggering tax recognition that otherwise would not occur at
this time. However, your club has experienced appreciation, and every member
will someday pay tax on that appreciation. The withdrawals have hastened the day
of recognition, but they have not resulted in any taxes by the other members
that would not someday be due.
Therefore, I am of the opinion that, if you sell stocks to pay
off some of your members, the burden of the taxes on those sales should fall on
all members (including the departing ones) in the ratio of their
ownership.
Having said that, there is a way to postpone this income
recognition. Instead of paying off the members in cash, use appreciated stock.
The remaining members pay no tax when payoffs are made in stock, and the
withdrawing members are no worse off than they would be if they had received
cash. In fact, they might be better off, since they will pay no tax until they
sell the distributed stock, whereas, with cash, the gain is taxable in the year
of receipt.
When stock is distributed in a total termination of a member's
position, the basis for the stock, in the hands of the member, becomes his/her
basis in the partnership, less any cash received. If a member receives more than
one stock, the adjustment of basis between the two can be a little complicated.
The NCA program will handle this type of withdrawal, and bivio has announced
that it will be capable of doing the same in a very short period of
time.
For more information on using appreciated stocks for members'
withdrawals, see the articles written by Jerry Dressel, at Jerry's Best on the
NAIC website, where Jerry has treated the subject in great depth. http://www.better-investing.org/clubs/jerrys-best.html
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