Partnership

MAX — Tue, 05 Aug 2008 02:40:51 GMT

I was recently named a partner at my firm (which is held out as a professional association), to the chagrin of some and delight of yet other partners. As we attempt to square everything away, and I jockey for equity partnership, versus mere profit sharing, I am being told by the less delighted that receiving equity partnership (ownership) without buying into the firm would result in a huge tax liability to me at the end of the year. Admittedly, I never was a numbers' person, but this doesn't have the ring of truth, as I suspect the firm itself will be taxed at year's end, as I will be, for that which I take home. That is, it sounds incongruous that say if the firm is worth $20,000,000, that I would be taxed on my share of the new-found ownership plus my take-home gross income. For example, say my ownership interest is worth $400,000.00, and my annual salary $250,000.00--how can I be taxed on $650,000.00 worth of income, when I only took home $250,000.00? If anything I would expect a later sale of my interest or buy-out could trigger taxation on the ownership interest (the $400,000.00), but at that point I would be realizing the actual monies as income.

Am I being fed hogwash by the naysayers, to get me to elect a profit-sharing agreement versus ownership??

Please help!!

RE: Partnership

profitbob — Tue, 05 Aug 2008 04:14:15 GMT

Go for the equity position and pay the taxes. You do owe income tax of some kind since the equity in the company is the same as being offered stock ownership or some other perk/benefit/bonus. It is all taxable as income, and in the case of company ownership or stock, capital gains taxes are owed when they are sold.

You need to consult a tax accountant qualified to handle this matter to determine your actual tax burden, but it is a one time thing. If you can't afford the tax all at once, you have time to prepare a payment plan with the IRS before the tax is due.

Whether you can make more money in the long run with profit sharing or a partnership is difficult to guess from here without any hard numbers. Even with the numbers, who can predict how long the company will last and what are its future prospects. You are the most qualified person to make those decisions.

If I were you, I would crunch the numbers and probably choose the partnership equity position and try to mitigate the tax bite as much as I could. The naysayers may actually be looking out for your best interests, but your inclusion into the partnership is diluting their shares, as new partners will dilute yours.

RE: Partnership

MAX — Wed, 06 Aug 2008 03:32:46 GMT

So that I am clear--takes a lot to clear money matters for me--you believe the tax consequences would not be triggered until I dispose of my interest in the firm through a sale, etc?

Thanks Profitbob!!

RE: Partnership

tax geek — Wed, 06 Aug 2008 12:56:12 GMT

if the firm is profitable then the equity stake is probably preferable, subject to the standard caveats. based on your example, if your share of the profts is 400K/year then you would be taxed on 400K of income, regardless of whether you took any income out (see IRC sections 702 and704). the 250K received as "compensation" would generally not be taxable since partner distributions are not taxable unless they exceed your partnership interest (see IRC section 731). another exception would be that the 250K would be taxable if it was classified as a "guaranteed payment."

RE: Partnership

profitbob — Wed, 06 Aug 2008 14:01:05 GMT

No, you are totally misinterpreting what I wrote. You will be taxed on the partnership as income for the year (or quarter) you accept it, and when you dispose of it. You need to consult with a tax professional before you make your decision so that they can make sure you understand all of your liabilities.

You should also consult with a business lawyer and have them explain your legal liabilities as a partner. It may be that the added responsibility outweighs the financial benefits of the partnership.

You have the money, spend it on getting some good professional advice. Trying to do things on the cheap won't work for you in this case as there are too many hidden pitfalls that most laymen won't recognize. Especially considering that your country's or state's laws and tax codes may be different from mine (since you don't say where you are from).