LLC Contribution for Interest

Wednesday, March 03rd, 2010 | Author: Richard

Question:

2 members are starting an LLC, 1 Member is contributing $75k in cash as initial capital contribution for a 50% interest (capital, profits & loss) and the other is bringing to the LLC his background, experience and expertise in the industry and ability to get business for the LLC for his 50% interest (Capital, profits & loss).

I was told 2 different scenarios, 1 is that the 2nd members interest was a contribution of an intangible asset, goodwill, and would not result in any taxable income to him for his 50% capital interest.

Then I was told, his expertise etc. was NOT considered good will, that he is actually obtaining his interest in the LLC for future services, therefore resulting in taxable income of $75k (value placed on his experience etc.) to him.

Which is the proper treatment and could you please reference a code section on reference for the correct treatment.

Answer:

Allow me to point out that capitalization is not a taxable event. So your contribution or his contribution will result in no tax due. Contributions set the “basis” for the ownership interest. Basis is used to calculate gain or loss when the ownership interest is sold.

So there is no tax event when you are starting up the business, period. The contributed value of the ownership interest creates no tax event while the business is operating, from year to year. The contributed value of the ownership interest may never create a taxable event.

The only time that the contributed value of the ownership interest would even have a tax consideration is when the owner either exchanges his ownership interest for money (sells it), or closes and liquidates the business and gets a distribution of assets (effectively selling the ownership interest back to the business to wind it up). At that point the difference between the adjusted basis and the sale price would either be a wash (same amount in and out), a gain (more came out than went in), or a loss, more went in than came out. Taxes would be calculated on that.

Now the basis does adjust, as the LLC is profitable, attributes tax liability to but does not give you money your basis is adjusted up.

Now I have to ask, why be an LLC? It provides no tax benefit over being the biggest of tax victims the General Partnership; It has been unsuccessful at limiting liability.

I know, your accountant said it was the best option, but did you really grill him on why? Because I am certain he will fall back to, it is the way that everyone is doing it.

But let me ask you, is that really true? Who is everyone, certainly not any of the most successful businesses . . .

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