LLC/Partnership Formation Key Issues: Distribution Rights, Capital Contributions, Income and Loss Allocations

Initial partnership considerations go beyond registering the name, applying for identification numbers, and preparing the Articles of Organization. Key to the formation is a partnership agreement that spells out how day-to-day and sticky aspects of running a business are handled.

Flexibility is a primary reason businesses select to operate as a partnership or LLC. Flexible allocations, however, must comply with the provisions of Section 704(b) and have substantial economic effect. Significant flexibility is allowed when initially funding the partnership. One partner can contribute property while the other contributes services. Issues arise with both. One partner could contribute property with a fair market value that is higher or lower than what he or she paid for it. The services partner may not be initially admitted to the partnership and his or her contribution will likely generate taxable income.

In addition to the known considerations, other key considerations are often overlooked. Transferring ownership and whether this right is unrestricted, payouts on dissolution of the partnership, and the level at which capital accounts are required to be maintained should all be addressed at formation. The BBA centralized partnership audit regime has escalated the importance of naming a partnership's representative and having predetermined procedures for handling prior period audit adjustments. Tax practitioners working with partnerships and LLCs need to be able to guide partners and members appropriately when they are establishing partnerships and LLCs.

Listen as our panel of pass-through entity experts provides a checklist of items to consider when forming an LLC or partnership.