Partnership Relief of Debt Penalty
It’s the American spirit to start new business and use the capitalist system to create new business and ideas to make money. As part of that endeavor, many people form partnerships to start their ventures. Sometimes those business ventures are successful and sometimes they are not. Sometimes you decide to sell your partnership share or part ways with your partner.
For tax purposes, the amount of income that you gain from selling your partnership share includes cash, any property that you receive, and your share of the partnership that you leave behind.
So in real life here is how this works. John and Jim have a partnership in which they do custom cars. They have different ideas in terms of how the business should expand. They haven’t been getting along. John proposes to buy out Jim’s share of the partnership. John offers to pay him $35,000 for Jim’s share. The business owes $20,000 in debt.
If Jim decides to sell his partnership shares to John, he will face some tax implications that he may not be aware off. Naturally, Jim will be taxed on the $35k that he sells his shares for. By selling out of the partnership he will avoid his share of the $20k debt (which is $10k). So the IRS will treat his benefits from the sell as $45,000. Jim will have to pay taxes on $45k if he elects to sell his partnership.
So be careful if you have a partnership and want to sell out your shares.