Who Should Pay the Tax on Members' Withdrawals
I had a question about member withdrawal.  We have nine members leaving.  I understand that when we sell our stocks to pay off the other members we will incur long term or short term capital gains taxes.  These taxes will be split among all of our members.  Other club members feel that these taxes are the responsibility of the people leaving because we are selling our stocks specifically for them.  What is the correct way to handle this?
This question comes up often. It is true that the members who are leaving are triggering tax recognition that otherwise would not occur at this time. However, your club has experienced appreciation, and every member will someday pay tax on that appreciation. The withdrawals have hastened the day of recognition, but they have not resulted in any taxes by the other members that would not someday be due.
Therefore, I am of the opinion that, if you sell stocks to pay off some of your members, the burden of the taxes on those sales should fall on all members (including the departing ones) in the ratio of their ownership.
Having said that, there is a way to postpone this income recognition. Instead of paying off the members in cash, use appreciated stock. The remaining members pay no tax when payoffs are made in stock, and the withdrawing members are no worse off than they would be if they had received cash. In fact, they might be better off, since they will pay no tax until they sell the distributed stock, whereas, with cash, the gain is taxable in the year of receipt.
When stock is distributed in a total termination of a member's position, the basis for the stock, in the hands of the member, becomes his/her basis in the partnership, less any cash received. If a member receives more than one stock, the adjustment of basis between the two can be a little complicated. The NCA program will handle this type of withdrawal, and bivio has announced that it will be capable of doing the same in a very short period of time.
For more information on using appreciated stocks for members' withdrawals, see the articles written by Jerry Dressel, at Jerry's Best on the NAIC website, where Jerry has treated the subject in great depth.
Rip West
Saint Paul, MN