BLOG: Introduction to taxation of sale proceeds: Partnership/limited liability company
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Our third and final post in the series “Introduction to Taxation of Sales Proceeds” addresses the taxation of sale proceeds if a target practice is a partnership, including an LLC treated as a partnership.
Below we provide a high-level summary of the U.S. federal income tax treatment of an asset sale by a partnership vs. a sale of partnership interests by the partners.
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State and local tax consequences must also be taken into account, which add nuances that need to be fully considered on a case-by-case basis. The tax consequences of a sale of a medical practice are complex, and it is important to consult with your tax adviser early on in the sale process.
Equity sale: Each partner (or LLC member) generally will recognize gain or loss equal to the difference between the portion of the purchase price received and the partner’s tax basis in her interest in the partnership. Such gain generally is capital gain, but a portion will be taxed as ordinary income to the extent the gain relates to certain underlying assets of the partnership whose sale by the partnership would give rise to ordinary income, including, among other things, inventory, unrealized receivables and property subject to depreciation recapture on sale.
Asset sale: The partnership generally will recognize gain or loss with respect to each asset equal to the difference between the amount of the purchase price allocated to such asset and the tax basis of such asset. As discussed above with respect to an equity sale, such gain or loss will be capital or ordinary depending on the type of asset. As with the sale of assets by an S corporation, gain or loss generally is not taxed at the partnership level and, instead, is taxed proportionately to the partners. However, partnerships have more flexibility on how gain recognized by the partnership is allocated among the partners. The sale proceeds generally can be distributed out to the partners without additional U.S. federal income tax.
As with an S corporation, the 3.8% net investment income tax generally does not apply to gain recognized on a sale of partnership interests, or gain allocable to a partner from a sale of the assets of the partnership, to the extent the relevant partner “materially participates” in the business of the partnership.
Observations: Unlike the purchase of stock of an S corporation or C corporation, a purchase of all of the partnership interests by the buyer generally is treated for U.S. federal income tax purposes by the buyer as a purchase of the underlying assets of the partnership (ie, the buyer obtains a tax basis step-up in the partnership’s assets). Thus, either an asset sale or equity sale is acceptable to buyers and sellers from a tax perspective. Other business considerations may drive the preferred deal structure, and state and local tax issues may also impact the decision.
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