In Foxman v. Commissioner, 41 T.C 535, 550-51 (1964), aff`d, 352 F.2d 466 (3d Cir. 1965), an outgoing partner has reached an agreement to sell all of its partnership shares to the two remaining partners. In each tax return after this transaction, the outgoing partner treated the transaction as a sale and declared a capital gain. However, the other two partners viewed the transaction as a withdrawal, resulting in a significant reduction in their share of the company`s revenue distribution and hence a more favourable tax result for both companies. Withdrawal agreements can offer a better tax offer to the remaining owners by avoiding “technical layoffs.” If more than 50 percent of CLLs are sold within 12 months, the IRS treats the business as if it had dissolved and reformed. When LLC claims amortization on assets as a business expense, this technical termination reduces the amount of deductible depreciation. Withdrawal of interest does not trigger this rule, so the amortization remains the same. Another advantage is that LLC may eventually deduct a portion of the payments to the former partner as a business expense. Carefully crafted withdrawal agreements can protect the remaining members from the burden of their untested or unknown successors and minimize the risk of litigation and stress among co-owners caused by the uncertainty of an outgoing owner.
However, the feasibility of these types of agreements should be subject to regular review. For example, feasibility is important to ensure that the company has sufficient resources to cash in the shares – and also for practice, to confirm that the terms and conditions are always in line with the needs and objectives of the owner and the company. The main reason is that the legal counsel must decide whether the transaction is structured by the LLC as a sale of outgoing member holdings (“outgoing member”) to a remaining member or as a withdrawal (or “liquidation distribution”) of the outgoing member`s shares. The consultant should also look at LLC`s operating agreement in order to obtain provisions relating to delegation limitations, procedures and termination requirements. Additional requirements often apply when the transaction is a sale and not a withdrawal. A transfer that is contrary to the operating contract may be considered invalid and the legal counsel should therefore review the enterprise agreement in its entirety in order to inform clients of the relevant provisions of the enterprise agreement and the California Revised Limited Liability Company Act. When a client requests the preparation of a purchase or sale contract for the interests of the limited liability company (GMB), the legal advisor should always gather additional information before preparing such an agreement in order to obtain a complete picture of the exchange.