A buyout, in general, is when a business organization repurchases an owner's stake in its association. When an owner is bought out, it is recognized as a capital transaction, which means that the individual has special reporting requirements and a lower tax rate than on ordinary income. The buyout of corporate shares is relatively straightforward, but the taxation of a partnership buyout is more complex as some of the income will be categorized as ordinary and the rest as capital.
Capital Items
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Things that are owed for investment purposes, such as corporate stock and partnership interests, are considered capital items. Gain and losses from these items are reported on Schedule D of your personal income tax return filed on Form 1040. The benefit of having gains classified as capital is that it is taxed at a rate of no greater than 15 percent. The downside of capital treatment is that net capital losses can only be used to offset taxable income up to $3,000 annually. If your losses exceed that amount, the difference can be carried forward to offset future gains.
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Corporate Buyout
To calculate the taxable gain or loss from the buyout of corporate stock, begin by multiplying the shares repurchased by the repurchase price. This will give you the amount recognized. Your basis in the repurchased stock is how much you originally paid for the shares. The gain or loss is calculated by subtracting your basis from the proceeds, the entirety of which is treated as a capital transaction.
Partnership Price and Basis
The Revised Uniform Partnership Act is the modern standard for partnership law and provides a good description of what occurs when a partnership buys out a partner. Under these rules, a partner departure is called dissociation. Per RUPA, the price of a partner's stake is the value of the partner's share of the partnership's property minus the partner's share of the partnership's liabilities. The valuation of the property and the liabilities are determined as of the partner's departure date. The partner's basis is the original investment plus his share of his business income during his tenure, along with additional contributions made by the partner. Then, subtract the partner's shares of the partnership's losses and all distributions made to the partner.
Taxing Partnership Buyout
The tax treatment of the partnership buyout depends on the composition of the partnership's assets at the point of dissociation. If the partnership's assets at the time of dissociation include receivables or inventory, some of the partners' proceeds will be treated as ordinary income. Unrealized receivables include any right to payment the partnership has for goods already delivered or services already provided. The proceeds from the sale that correspond to the partnership's receivables or inventory are treated as ordinary income. For example, if a partnership had $100,000 in assets at the time of dissociation and $10,000 of those assets were inventory, 10 percent of the dissociated partner's proceeds is ordinary income. After deducting the receivables and inventory amount from the proceeds, the capital gain or loss is calculated by subtracting the partner's basis from the remainder.
Tax Tips and Disclaimer
For complex returns and partnership transactions, consult with a tax professional, such as a certified public accountant or a licensed attorney, who can best address your individual needs. Keep your tax records for at least seven years against the possibility of an audit.