Business interest realignment through revaluations and special allocations.

• Author: Schlueter, Joseph F.
• Position: Taxation

The rapid evolution of the limited liability company (LLC) from essentially a two-state curiosity to the preferred entity of choice for business structure, has thrust Subchapter K to the front of every tax adviser's practice. A primary benefit of being taxed as a partnership under Subchapter K lies in the tremendous flexibility available to its owners, particularly in arranging the manner in which profits and losses should be shared. This flexibility makes Subchapter K one of the few truly creative weapons in a knowledgeable practitioner's arsenal. An excellent example of this flexibility is the ability to restructure profit and loss allocations.

During the life cycle of any business, the business and its owners will have changing needs or circumstances. Entities structured as partnerships or LLCs can quickly adapt to these changes. As the following example illustrates, it is possible to restructure the allocations associated with various aspects of a particular business without having to break apart the business in a taxable transaction.

Example: An LLC, A, was formed in 1993, and since that time has been involved in two distinct lines of business--the manufacture and sale of baseball bats and the manufacture and sale of fishing poles. A has quickly gained a reputation for producing high-quality products in each market, and with the growth of sales through catalogs and the Internet, the value of the business has risen dramatically over the years. A's members include N, L and R, who currently have stated ownership interests of 45%, 45% and 10%, respectively. The three members (who are not related) have shared in the management of both lines of business.

Currently, L sees substantial growth opportunity in the fishing pole business, and would like to focus all his energies in that direction, while N sees the same opportunity in the baseball bat business; R would like to retire. However, business and financing considerations prevent A from being divided at this time.

The members would like to restructure A into two divisions and provide L and N with complete control of a division. In addition, the allocation of the profits and losses would be restructured, so that a preferred return equal to 5% of the capital invested in each division would be allocated between L and N equally, with all remaining profits from each division being allocated to the respective member.

Proposed methodology. The members' objectives can easily be accomplished in the...