Business Partners Split

[Forensicacctnt]

There are two partners (50/50) and my client is getting out of the business. He did not contribute any money since the time he was a partner starting September, 2018. Only sweat equity. The business has done very well since it started in March, 2016. Estimated revenue this year to be $730K and net income $130K. What is the best way for his taxes to have the "buyout" structured? Second, because he has only sweat equity then his basis is zero? Thanks

[kathyc2]

If the income from K-1 has been more than the distributions he received, he would have basis from that. By buyout, are you saying that he would receive an amount to leave the partnership?

[ATSMAN]

Generally in partnerships with sweat equity, only the profits are split based on some agreement. Upon termination the sweat equity partner does not get any of the partnership assets. I think if assets are distributed then that becomes taxable at fair market value. I am a bit rusty with these laws so please double check and correct if I am wrong.

[Forensicacctnt]

My client is looking to receive a sum of money for his share of the partnership value to leave the business. He and the other partner do not get along at all. He has tried everything he knows to help his partner, but to no avail. Regarding the K-1 for 2018, he has inquired and not heard from the CPA about the return and his K-1.

[Burke]

My client is looking to receive a sum of money for his share of the partnership value to leave the business. He and the other partner do not get along at all. He has tried everything he knows to help his partner, but to no avail. Regarding the K-1 for 2018, he has inquired and not heard from the CPA about the return and his K-1.

He needs to get aggressive and visit or call the CPA directly to inquire about the K-1 and whether any income is going to be attributable to him for 2018. As a general partner he is entitled to a copy of the entire tax return if he desires. Filing deadline for 1065 (on extension) was Sept 15, 2019.

[kathyc2]

My client is looking to receive a sum of money for his share of the partnership value to leave the business.

I'm not sure this is reasonable to ask for 1/2 the total value of partnership. As you said it was doing well before he entered it. In the year when he was involved did he do anything to increase future profitability such as bring in customers, instigate cost saving measures, etc? How much he will receive will need to be negotiated between himself and other partner.

[Dude]

I thought sweat equity was usually associated with one of the businesses founders. Your client was brought in 2 years after the business started. I think you should ask to see the partnership agreement and make sure his sweat was calculated as 50% ownership.

[ATSMAN]

I thought sweat equity was usually associated with one of the businesses founders. Your client was brought in 2 years after the business started. I think you should ask to see the partnership agreement and make sure his sweat was calculated as 50% ownership.

That should have been the first place to start, the "agreement". I used to run into sweat equity agreements between house flippers where one person provided all the "muscle" to rebuild and the other partner was responsible for financing the projects. Profits from sale would typically be split equally but sweat equity partner did not have claim to any inventory or assets of the partnership.

[Burke]

That should have been the first place to start, the "agreement"...... Profits from sale would typically be split equally but sweat equity partner did not have claim to any inventory or assets of the partnership.

I agree. Termination of partnership interests should have been covered in an operating agreement or Buy/Sell agreement. If there is no written document, or oral agreement that can be corroborated by a 3rd party or other evidence, then he has some negotiating to do.