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Me and my son have a business in California and want to dissolve our partnership, what steps do we need to take?

By: Rick Gossett

 

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I would like to dissolve a California business partnership between myself and my son. What steps do we take and what forms and announcements do we need to comply with?

 

Answer:
A. Partnership dissolution: Whether you or your son will continue operating the business or the business is also being discontinued is one important consideration; however, partners have several important considerations regarding dissolution, including a predetermined formula or appraisal method for valuing the business in a buyout by another partner, the valuation and transfer of any business name, trademarks, or other intellectual properties, potential payment arrangements in a buyout, selection of an arbitrator or other method to handle legal disputes, and liability indemnification for a departing partner.

We don’t know the details of your partnership and its agreements, but typically, the handling of ownership changes in a partnership will be outlined in the partnership agreement. A general partnership generally uses a partnership agreement, which serves as a legally binding contract in the event of any disputes and to delineate the legal, operational and financial relationships between the partners. Partnership ownership changes typically require the approval of all partners, but your Partnership Agreement may address the specific requirements.
For tax purposes, a partnership terminates when at least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner, even if the sale or exchange involves zero consideration (money or property). Also, a partnership terminates when one partner in a two-partner partnership buys out the other and the remaining partner continues operating the business as a sole owner business. When a partnership terminates, there is typically a liquidating distribution made to all partners. This distribution can have tax consequences depending on each partner’s adjusted basis in their partnership interest. Generally, the partnership agreement will address how the partnership handles termination of the partnership and liquidating distributions.
In owner dispute situations, an owner generally wants to, or should, be bought out to terminate the relationship and avoid problems in the future. Without a Partnership Agreement, buy/sell or other legal arrangement, the buyout negotiations can be difficult and the potential issues in these situations – employee termination, partner buyout, personal guarantee release – can be very emotional, difficult to resolve, and legally complicated. For example, personal guarantees generally cannot be canceled and may require a business or personal indemnification for departing partners. Also, while all ownership changes do not require formal notifications, many business contracts and loan agreements have change of control clauses that must be considered. Business partners do resolve disputes themselves in some cases, but often these situations require legal counsel to properly evaluate and plan the negotiations, solution, and documentation as well as help prevent any lawsuits and minimize the legal fees for all parties. To determine the best way to manage your partner’s departure from the partnership, we recommend that you review the details of this matter and your business agreements with your lawyer.
Dissolving a general partnership generally requires a form of dissolution agreement. You can find sample partnership dissolution agreements (some free and others for a fee) at websites like the following, which include these basic considerations:
–    Notify state and federal tax authorities that the partnership is dissolving
–    Turn in a dissolution and liquidation form to the state in which you do business (this is not always required but is always a good precaution to take)
–    Notify all creditors that the partners are no longer responsible for the debts of the others
–    Notify all suppliers, customers, and clients of the dissolution

Sample Agreements:

Links and references to sample and template documents have been provided pursuant to your request. Templates and sample documents can be very useful but businesses should exercise caution in the use of such documents. Understand that not all templates are created equal, with many being created for a narrow set of requirements. A particular template will not be warranted to cover every provision that may be required by a particular set of business circumstances. Studying the language included in various samples and templates will improve your level of understanding related to the subject of your particular agreement and may help you articulate your business objectives related to an agreement, but be aware that many, perhaps most, agreements should be prepared by your lawyer to provide greater assurance that your interests have been protected.

B. Final Partnership Tax Returns: Keep in mind that a partnership terminates when one partner in a two partner partnership buys out the other, and the remaining partner continues operating the business as a sole-owner business. Short period tax returns will be required for the year of the termination as discussed in Publication 541:
“A partnership terminates when one of the following events takes place.
1. All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership.
2. At least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner.
Unlike other partnerships, an electing large partnership does not terminate on the sale or exchange of 50% or more of the partnership interests within a 12-month period.
See section 1.708-1(b) of the regulations for more information on the termination of a partnership. For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1.708-1(c) and 1.708-1(d) of the regulations.
Date of Termination: The partnership’s tax year ends on the date of termination. For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. For the event described in (2), above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or exchanges in the preceding 12 months, transfers an interest of 50% or more in both capital and profits.
Short Period Return: If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. The return is due the 15th day of the fourth month following the date of termination. See Partnership Return (Form 1065), later, for information about filing Form 1065.”

Published: May 14, 2014
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Rick Gossett

As COO of Tarkenton Companies for more than 20 years, Rick has been responsible for business software development, unique partnerships, business educational content and consulting, and more. Rick was the originator of Tarkenton Companies’s consulting service and initially handled all of the questions himself. Prior to joining Tarkenton Companies, Rick owned and operated a private practice as a CPA. Prior to that, he was a Senior Manager at Pannell Kerr Forster in tax and audit, as well as Principal in Ernst & Young's small business advisory group.

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