I hope you are all well! This is message is part of the educational program series that was started by the authors last month in order to provide you with insights relating to many of the issues that businesses and business owners may begin to face due to the downturn in the economy as a result of the COVID-19 pandemic and collapse of energy prices and the related market. Our initial email was sent to you via BCC, and thereafter the next two emails were sent by a third-party provider. Based on several of you asking about the last two emails, as apparently such large email sent by a third-party provider is caught in spam, we will be sending future emails via BCC.
Today, we will address some of the key tax issues related to a recapitalization of an entity taxed as a partnership (including a multiple member LLC).
First, in analyzing any such recapitalization, it is important to consider a few issues that affect or relate to the contributing party:
- Does the recapitalization involve non-cash assets, and if so, does the contribution qualify for tax free treatment, allowing the contributor to defer any gain (i.e., on date of contribution the fair market value of the assets contributed is in excess of its tax basis);
- Is part of consideration provided by the contributing party a contribution of services which do not qualify for tax-free treatment (unless structured as a profits interest); and
- How and when should gain/loss in the non-cash assets contributed as part of the recapitalization be recaptured (i.e., direct Code Section 704(c)) into taxable income by the contributing party;
Second, in analyzing any such recapitalization, it is important to consider a few issues that affect the existing partners/members:
- the consequences of a partial shift of the applicable entity’s existing debt for purposes of Code Section 752 from the existing partners/members to the contributing party, which (absent potential or proper planning) will cause:
- a reduction (i.e., limitation) in utilization of future losses by existing partners/members (and loss of some of benefits afforded by certain of the recent changes in law noted above); and/or
- a gain resulting from a deemed distribution of cash
- the consequences resulting from revaluation/book-up of the assets inside the applicable entity in connection with the recapitalization, which (absent potential or proper planning) may cause an acceleration of future taxable net income allocations to the existing partners/members.
The foregoing is merely intended to identify the primary tax issues that need to be considered in connection with a potential recapitalization of an existing business with additional equity capital. The authors hope that you and/or your clients find this email informative should a recapitalization event become necessary in connection with a business venture. If you have follow up questions please feel free to reach out to either of the authors of this email. Until next time, stay safe and have a great week!