Partnership Interests and Succession: Key Tax Issues for Family-Owned Businesses

Welcome back to our business succession planning article series. In our previous article, we covered the tax considerations when transferring S-Corp shares to family members. We discussed capital gains and how the step-up in basis adjustment offers tax advantages. Today, we'll explore tax considerations when transferring interests in partnership-taxed LLCs or partnerships. Continue reading for more insights.

How Partnership Structures Work

When setting up a company for taxation purposes, business owners have two options:

  1. They can form an LLC that is taxed as a partnership. In this structure, the LLC itself does not pay taxes on its profits. Instead, these profits are passed on to the members, who report them on their individual tax returns.
  2. Alternatively, they can establish a partnership. This business structure is treated similarly for tax purposes as an LLC that chooses to be taxed as a partnership, utilizing pass-through taxation.

In both cases, business owners agree to share the profits and losses of their business, and the entity itself is not taxed at the company level.

Tax Implications of Transferring Partnership Interests

As discussed in our previous article, the tax treatment of transferred partnership interests depends on the transfer method: either as gifts during your lifetime or as inheritance after death.

The difference between the sale price and carryover basis is subject to capital gains tax for gifted partnership interests that are later sold. Similar to S-Corp stock, partnership interests sold within one year are generally subject to higher short-term capital gains tax, while those sold after a year of ownership are generally subject to long-term capital gains tax.

When partnership interests are inherited upon a partner's death, the step-up basis generally applies. This means the basis of the interests is adjusted to the fair market value at the time of the partner's death. If heirs later sell these interests, capital gains tax will be based on the difference between the sale price and the stepped-up basis, potentially reducing their tax liability.

Lastly, it's important to note that lifetime exemption and annual exclusion rules also apply when gifting partnership interests to family members.

Conclusion

We have concluded our discussion on the tax implications of inheriting or gifting partnership interests. Join us for the next piece, which will discuss tax considerations when transferring C-corp shares. See you then!

Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.

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Categories: Succession Planning