AccountingBLOCK - Tax and Accounting Forums

Considering converting a single member LLC to multiple member electing partnership status.

Gift interest to new members or charge. Also considering establishing option to purchase additional share. Option price to be set at current book value. Thinking about multiple period option dates under the same agreement. Can there be a final option period, at the same stated price, in the event of death?

What steps should be taken? Any cutoff date concerns?

Any suggestions, issues or other things to consider?

Single Members LLC Topic
If admission of new 1% member is a nominal interest designed to trigger federal recognition
or partnership status, then gifting interest is sufficient to nonfamily member. I am reminded of the "death-bed" transfer
stories reporting failure to recognize bona-fides relating to vesting on Family Limited Partnership
interests. If the LLC interest is valued at less than $10,000, no problemo.

Valuation Discount (vd)
1% interest in LLC valued at $500k = $5k. Considering a valuation discount for the minority interest
holder, the $5k valuation adjustment (vd) is:
$5,000 x .70 (vd) = $3,500

Options & LLCs
Option at book value (bv) ignores option premium rule. Try option = (bv x vd adjustment) + (vd x 5% p/yr to option
maturity) adjusted for business or market conditions. Example, GM options are less likely to command premium.
Options for LLCs can trigger a Tax Termination, if, shares transferred exceed 50%.

"A sale or exchange of interests in a Seller Partnership that represent 50% or more
of the total profits or capital interests of that partnership causes a termination of the Seller
Partnership for income tax purposes (a "Technical Tax Termination"). In a Technical Tax
Termination, the partnership is required to obtain a new tax ID number even though it is
the same entity under state law as the partnership prior to the Technical Tax Termination
and is generally treated as a new entity for income tax purposes, with any property owned
by the partnership treated as having a new PIS for general income tax purposes."

Non LLC Entities Disregarded as Seperate From Owner
If you desire the nonfiling status of SMLLC, consider the Limited Liability Trust in Delaware or Statutory
Business Trust in Nevada. Multiple member LLTs are classified as "grantor trust", corollary to SMLLC,
if significant powers are vested in LLTs "owners", oft referred to as shareholders.

LLT Lingo:
LLC: Managers and Owners
LLT: Trustees and beneficiaries (aka, shareholders)

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Don't you mean 13,000 instead of 10,000 for no problem re gift.

The initial interest of new members would be 1%.

So then, if the gift tax maximum is adhered, to then no problems in gifting or selling options at a current valuation (09), allowing exercise over a 5, 10 or 20 year period (or upon death) at (09) price is no problem. The options when fully excercised would be a complete transfer of interest.

Of course the option contract would be formalized and drawn by legal counsel.

Yes, gift tax is a possible hurdle. I selected $10,000 as a "nice round number" derived from
deathbed transfer cases.

A concept in partnerships exists referred to as "genuine partner" status. Essentially,
a partner's status may be reclassified, similar to independent contractor versus employee, if
the partner is not deemed a genuine partner. Proliferation of LLCs accentuates
the relevance of the aforementioned classification.

Genuine partner: status of actual partner with rights associated with law of partnership. Creditors
with assignments of partnership income are not classified as genuine partners nor are
LLC option holders. Consider your LLC interest via option and the valuation discount.
If an LLC Member's 1% interest is significantly limited, the classification may be nonpartner
a. lack or restriction upon of voting rights
b. lack or restriction of inspection of partnership property
c. inability to contract on behalf of partnership
d. restriction in interest clause relating to transfer or assignment
e. restriction on inspection of partnership records

Evergreen Option:
A variation to options, an evergreen option gives the holder an irrevocable and reoccurring
right to renew option similar to an automated bank account electronic transfer (ebill payment).

How to create an evergreen option:
Add a paragraph to the LLC operating agreement (email me for a .doc version)
Print Option to Purchase LLC Interest with evergreen option

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Option v Partnership Preferential Return (common v preferred shares)
Interest in partnership may be defendant upon condition precedent or subsequent.

Percentage is a Corporation Concept
'S-Corpers understand that creation of a second class of shares violates S-Corp
qualification. Partnerships enjoy freedom to structure capital interests and income share
distributions in creativly. Example:

Partner 1 owns 100% of income and capital distributions to $250,000, subject to partner 3 and 4 distribution terms
Partner 2 owns 1% of income distributions from $250,000 to $500,000
Partner 3 owns .5% of income and capital distributions from $100,000 to $250,000
Partner 4 owns 1% of all income IF the partnership capital exceeds $1,000,000

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Even with options I don't see any entries required unless exercised.

It looks like the single member will gift to two new members at 1% each.

Since the LLC will now require a written operating agreement, I'm thinking that as a controlling type document (recognized by the IRS) that it should allow for all members to make additional capital contributions (if the original member chooses not to make additional contributions when the others do) then the original member's interest will be diluted as those other members make their new contributions.

This eliminates the need for an option contract between the original member and the two new members and would keep it cleaner (as all members would be related parties).

Any flawed logic here?

Written LLC operating agreements
Not required; Uniform LLC default statutes govern via Uniform LLC act and/or Uniform
Partnership Act(s). Contrary argument: parol (verbal) LLC agreements designed
to own real property or termed in excess of 7 years may violate Statutes of Fraud
(designed to require designated contracts to be in writing). Complicated argument
relating to real versus personal property of LLC interests similar to option discussion: Is
the LLC interest real or personal property. A: Depends on terms of LLC shares.

LLC Members Capital Contributions
As a 1% member, an option with a strike price is preferred. Transfer or sale of 1% interest, subsequent
to formation, without option contract, should be valued at time of sale. Ergo, the 1% partner(s)
may be "locked out" if the value exceeds perceived value of subsequent contribution or exceeds
Members economic capability.

Avoiding Options
Consider LLC in series (Delaware LLC) or subsequent re-contribution clause. Helse favors subsequent
contribution clauses over options to purchase. Consider the Corporation concept of Treasury shares versus
partnership accounting. 100% of partnership is owned by partners. Partnerships do not own their shares*. An
option obligates partners to shift interests at behest of option holder.
* exceptions to rule exist via trusts for benefit of partners with partnership named as trustee.

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I am new to this forum.Its very nice and interesting to read.
It helps me to know more about tax...
Thanks for all your posting....
..............

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