Question

1. Tammy, Rebecca, and Miriam are partners in TRM Consulting, LLC, which will receive partnership tax treatment as the default for tax purposes. Tammy, Rebecca, and Miriam contribution $50,000, $25,000, and $25,000 of cash. In addition, the partnership agreed to take on a non-recourse loan of $20,000 from Miriam. Rebecca would like to contribute services to the partnership and is considering asking for additional profits interest in return for the service. Without the service, Tammy, Rebecca, and Miriam’s profits interests would be 50%, 25%, and 25%, respectively. Answer the following questions to help Rebecca think about what would happen if she performs the services for the additional profits interest.
   1. (4 points for each partner’s full answer) If Rebecca opts to ask for an additional 10% profits interest (taking 5% away from Tammy and 5% from Miriam), do any of the partners have to immediately recognize taxable income or a deduction on the transactions above? If so, how much income (or deduction) is recognized for each partner and what is the character of the income (or deduction)?

b. (4 points for each partner) Continuing from part a., how much would Rebecca’s service in exchange for profits interest change each partner’s outside tax basis (if at all)? If there is change, make sure it is clear whether the change is positive (increases outside tax basis) or negative (decreases outside tax basis).

Answer 1

Assume Total Income of LLC is $ 1,000,

It is assumed that the Profit of Partnership is exempt in the hands of Partners.

In normal Course if Rebecca is not asking for a 10% Share in profit for its Service, we call it the original profit-sharing ratio.

Tammy 50% share in profit $500 (Tax-Free Income)

Rebecca 25% share in profit $250 (Tax-Free Income)

Miriam 25% share in profit $250 (Tax-Free Income)

Point A: Rebecca is asking for 10 % of its share for rendering Services in Partnership firm.

Now, Profit Sharing Ratio if Rebecca ask for 10% Share

Tammy = 50%-5% = 45%

Rebecca = 25% + 5% + 5% = 35%

Miriam = 25% - 5% = 20%

Revised Share of Profits is as Follows

Tammy 45% share in profit $450 (Tax-Free Income)

Rebecca 35% share in profit $250 (Tax-Free Income) & $100(Taxable for Working Services)

Miriam 20% share in profit $200 (Tax-Free Income)

Point B

Hence change in profit Sharing is

Tammy -$50 (No impact on Tax)

Rebecca +$100 (Increase in tax liability due to Income of Services Work)

Miriam -$50(No impact on Tax)