Partner Buyout Treatment

My client, an LLC tax as a partnership, bought out a partner for $90k in cash. The purchase and sale agreement states:

For avoidance of doubt, the purchase of the Interest by Company from Seller eliminates any claim by Seller for a capital account balance, undist profits, or any other claims for participation in profits of the Company up to, and including, the Effective Date. The purchase of the Interest represents the purchase of Seller's entire Transferable Interest in the Company, as of the Effective Date.

My understanding is that the payment can be treated by the partnership in one of 2 ways:

1) Sec 736(a) - deductible by partnership, guaranteed payment to exiting partner
2) Sec 736(b) - considered payment for exiting partner's share of partnership assets. Partnership cannot deduct these payments.

Am I safe in treating this buyout as Sec 736(a) guaranteed payment to existing partner? No 1099 required as it will be reported as GP on Form K-1?

Thanks for you help, I appreciate it.

If they are buying out his interest, I would think 736(b) would be more likely, at least up to the balance of his capital account. Maybe 736(a) if paying more than capital account. Treatment will depend on partnership agreement.

No 1099 needed in either case.

If they are buying out his interest, I would think 736(b) would be more likely, at least up to the balance of his capital account. Maybe 736(a) if paying more than capital account. Treatment will depend on partnership agreement.

No 1099 needed in either case.

Thanks for your thoughts on this! Shareholder capital account balance (704(b) book) was $92,443 per 2018 K-1 (this is a new client, trying to get a handle on it all).

excerpt from operating agreement:
If the Company accepts the Withdrawal Offer, the Company shall purchase
the Withdrawal Interest for a price equal to 75% of the amount the Withdrawn
Member would receive if the Company were liquidated and an amount equal to
the Book Value (defined below) if it were available for distribution to the Members
pursuant to paragraph 6.4, less any liens or encumbrances on the Withdrawal
Interest or other amounts owed by the Withdrawn Member to the Company. The
Withdrawal Purchase Price shall be paid on an installment basis, such payments
shall be in equal monthly installments of principal over a period that shall expire
no later than two years from the Withdrawal Closing Date, with simple interest on
the unpaid balance of 5% per annum.

a. The term “Book Value” means the book value of the Company as of the end of the last full calendar quarter immediately preceding the month in which the event giving rise to the purchase and sale of the Membership or Economic Interest occurred, as determined in accordance with the terms of this paragraph 6.4. Notwithstanding anything contained in this Agreement to the contrary, the computation of Book Value shall be subject to the following provisions:

(1) Book Value shall not include any proceeds collected or collectible by the Company under any policy or policies of life or disability insurance insuring the life or disability of a Member.

(2) No additional allowance of any kind shall be made for the goodwill, trade names, or any other intangible asset or assets (the “Intangible Assets”) of the Company other than the aggregate dollar amount for any of those Intangible Assets appearing on the most recent balance sheet of the Company prior to the date on which Book Value is to be determined.

(3) Reserves for contingent liabilities shall not be treated as a liability for purposes of determining Book Value.

(4) No adjustment shall be made to Book Value as a result of any event occurring subsequent to the date as of which Book Value is to be determined.

(5) Anything contained in this Agreement to the contrary notwithstanding, Book Value shall be calculated for the purposes of this Agreement on an accrual basis even if the Company shall have used a different accounting method for that or any prior period.

b. Book Value shall be determined by the accountants regularly employed by the Company. For the purposes of this Agreement, the determination of such accountants shall be binding and conclusive upon all parties.

The balance sheet (accrual basis) at 3/31 buyout date showed cash of $200k, AR of $300k, NBV F.A. $20k, AP & other liab ($330k), NBV ~ $190k. As long as the $88k buyout doesn't exceed partner's 704(b) cap acct balance is it correct to classify the $88k as return of partnership capital (i.e. distribution)?

I haven't done a buyout before so this is all new to me. Any advice is appreciated.

I had two windows open and responded to your other commentary on this thread - moving it.

Ha ha, sorry about that!! I have babies so of course I read his name as Huggies

Yes, looks like a liquidating distribution to me. Check Sec 751 for possible tax and reporting issues if there are "hot assets".