J&J, LLC, was in its third year of operations when J&J decided to expand the number of members from two, A and B, with equal profits and capital interests, to three members, A, B, and C. The third member, C, will contribute her financial expertise to the LLC in exchange for a one-third capital interest in J&J. Given the balance sheet below reflecting the financial position of J&J on the date member C is admitted, what are the tax consequences to members A, B, and C, and to J&J, when C receives her capital interest? If, instead, member C receives a one-third profits interest, what would be the tax consequences to members A, B, and C, and to J&J?J&J Limited Liability CompanyBalance Sheet? BasisFMV BasisFMVCash$20,000$20,000Account Payable$7,000$7,000Inventory5,0005,000Mortgage

Question

Payable20,00020,000Equipment10,00017,000   Building30,00045,000A-Capital22,00030,000   B-Capital16,00030,000Total Assets$65,000$87,000Total Liab. and OE$65,000$87,000

What will be an ideal response?

Answer 1

If member C received a one-third capital interest for her services, the following tax consequences would result:
A is allocated a $10,000 expense, reducing A's FMV capital account to $20,000 and his tax basis capital account to $12,000. His tax basis would include a one-third share of the LLC debt, or $9,000. 
B is allocated a $10,000 expense, reducing B's FMV capital account to $20,000 and his tax basis capital account to $6,000. His tax basis would include a one-third share of the LLC debt, or $9,000. 
C reports ordinary income of $20,000 as a guaranteed payment for services provided. C's FMV and tax basis capital account will equal $20,000. Her tax basis would include a one-third share of the LLC debt, or $9,000. 
J&J, LLC-No gain or loss recognized and no adjustments to assets and liabilities. Members' capital accounts are adjusted as indicated. 
If member C received a one-third profits interest for her services, the following tax consequences would result:
A-No deduction would be available to member A because member C would not receive anything if the LLC were to liquidate immediately after the contribution. His tax basis would include a one-third share of the LLC debt, or $9,000. 
B-No deduction would be available to member B because member C would not receive anything if the LLC were to liquidate immediately after the contribution. His tax basis would include a one-third share of the LLC debt, or $9,000. 
C-Member C would not recognize any income because the liquidation value of her partnership interest is zero with a profits interest. Additionally, member C would have $0 in both her FMV and tax basis capital accounts. Her tax basis would include a one-third share of the LLC debt, or $9,000. From this point forward, C's capital accounts will be adjusted to reflect her share of future LLC profits and losses. 
J&J, LLC-No gain or loss recognized and no adjustments to assets and liabilities.