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Editorial 9 MIN READ

Member-to-member buyout, 2019: what changed after TCJA

The technical-termination trap is gone, the basis-adjustment math is unchanged, and §199A is now in the sale price

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 7 sections
  1. What TCJA actually repealed
  2. The two structures, still two structures
  3. The § 754 election and the § 743(b) adjustment
  4. § 199A is now in the sale price
  5. What the operating agreement should already say
  6. The 2019 checklist
  7. Sources

ne member of a multi-member LLC is buying another out in late 2019. The headline change since the 2017 version of this guide is that the technical-termination rule under IRC § 708(b)(1)(B) no longer exists. Everything else, basis adjustments under § 754 and § 743(b), the character split under § 736, the ordinary-income look-through under § 751, still governs the deal.

The new thing is § 199A. The qualified-business-income deduction is now two filing seasons old, the final regulations came out in January, and it has priced itself into partnership interests in a way the 2017 piece could not anticipate.

What TCJA actually repealed

Section 13504 of the Tax Cuts and Jobs Act, Public Law 115-97, repealed IRC § 708(b)(1)(B) for partnership taxable years beginning after December 31, 2017. The old rule: a partnership terminated for tax purposes if, within any rolling 12-month period, there was a sale or exchange of 50 percent or more of the total interest in both partnership capital and profits. That forced a short tax year, a second Form 1065, a reset of depreciation lives, and a re-examination of every partnership election.

It is gone. For a buyout closing in 2019, the partnership continues uninterrupted under § 708(b)(1)(A), which now provides the only path to termination: the partnership ceases to carry on any business, financial operation, or venture in partnership. A two-member LLC where one member sells their entire 50 percent to the other still converts to a disregarded entity, because a single-member LLC is not a partnership for federal tax purposes; that result is structural, not a § 708 termination. A 60/40 LLC where the 60 sells to the 40, a transaction that would have technically terminated the partnership under the pre-2018 rule, is a clean transfer in 2019 with no short year and no reset.

For closings that straddled December 31, 2017, the repeal is not retroactive. If a rolling 12-month window triggered the old rule for a transfer completed in 2017, the termination happened. Post-2017 transfers are under the new regime, full stop.

The practical effect: you no longer have to plan the closing date or the sequencing to avoid crossing 50 percent within 12 months. Tranched buyouts can be structured on commercial logic alone.

The two structures, still two structures

The choice between a cross-purchase and a redemption is unchanged. A cross-purchase is the buying member writing the seller a check directly for the seller's interest. The seller recognizes capital gain or loss under IRC § 741, computed against outside basis, with ordinary-income look-through for unrealized receivables and inventory under IRC § 751. The buyer's outside basis equals what they paid. There is no entity-level event.

A redemption is the LLC paying the departing member for their interest, which is governed by IRC § 736. The payment splits into two buckets. § 736(b) covers payments in exchange for the member's share of partnership property, generally capital in character at the seller's level and nondeductible at the partnership level. § 736(a) covers the residual, which is either a distributive share (if determined with regard to partnership income) or a guaranteed payment (if determined without regard to partnership income), and is ordinary at the seller's level and deductible (or a reduction in continuing members' distributive shares) at the partnership level. § 736(b) excludes unrealized receivables and, for partnerships where capital is not a material income-producing factor, goodwill; those drop into § 736(a).

Character is what the seller cares about. Deduction is what the buyers care about. Because those interests are opposed, the 736(a)/(b) split is a negotiated term, and the IRS will respect a reasonable allocation in the purchase agreement. Paper the allocation. Do not leave it to a preparer to reconstruct in April.

The § 754 election and the § 743(b) adjustment

None of the basis-adjustment mechanics moved. When a partnership interest is sold or exchanged, the buyer's outside basis equals what they paid. The partnership's inside basis, the basis it holds in its assets, does not move automatically. Without an election, the buyer eats phantom gain on the partnership's eventual disposition of appreciated assets they already effectively paid for at the interest level.

IRC § 754 is the election to adjust inside basis when interests change hands. The adjustment mechanism for a transfer is § 743(b): the transferee gets an adjustment equal to the difference between their outside basis (what they paid, plus their share of partnership liabilities) and their proportionate share of the partnership's adjusted basis in its property. The adjustment is personal to the transferee; the other members' inside basis is not affected. IRC § 755 provides the rules for allocating the adjustment across asset classes, first between capital-gain property and ordinary-income property, then within each category.

Two procedural notes that matter in 2019. First, the election is made by attaching a written statement to a timely-filed Form 1065 for the year of the transfer. Under Treasury Decision 9833, published in October 2017 and effective for taxable years ending on or after August 3, 2017, the partnership representative no longer needs to sign the election; the signature requirement was removed to reduce the incidence of invalid elections. This is a quiet fix that removed a recurring practitioner trap.

Second, once the § 754 election is made, it binds the partnership for all future years and also triggers § 734(b) adjustments on later distributions. Those adjustments can be upward or downward. An LLC that expects to distribute depreciated property at some point should run the math before electing; for the typical operating LLC holding appreciated goodwill and equipment, the election is close to a default good choice.

Mandatory basis adjustments still exist regardless of election. Under § 743(d), if a transfer of an interest would result in a "substantial built-in loss" (the partnership's adjusted basis in its property exceeds its fair market value by more than $250,000), the § 743(b) adjustment is required. TCJA also added a transferee-level test: a substantial built-in loss exists if the transferee would be allocated a loss of more than $250,000 on a hypothetical disposition of all partnership assets at fair market value. That expansion took effect for transfers after December 31, 2017, and is worth testing in any buyout where the partnership holds assets underwater by that magnitude.

§ 199A is now in the sale price

The qualified-business-income deduction under IRC § 199A gives an individual owner of a pass-through a deduction of up to 20 percent of qualified business income, subject to taxable-income thresholds, wage and property limits, and a carve-out for specified service trades or businesses. For 2019, the taxable-income thresholds where the limits begin to phase in are $160,700 for single filers and $321,400 for joint filers, indexed annually.

The final regulations, Treasury Decision 9847, were published in the Federal Register on February 8, 2019, and govern tax years ending after that date. They settle, for purposes of a buyout, the rules that matter at transfer.

Three points bear on pricing a 2019 buyout.

First, the K-1 reporting. Under Treas. Reg. § 1.199A-6 and the Form 1065 instructions, the partnership reports each member's allocable share of QBI, W-2 wages, and unadjusted basis immediately after acquisition (UBIA) of qualified property on Schedule K-1 (Statement A). For the year of transfer, these items are allocated between the selling and buying members under the general partnership allocation rules, which in most cases means an interim closing of the books or a proration election under § 706. The buyer wants the allocation method that accelerates QBI items into their ownership period. The seller usually has the opposite interest. Settle the method in the purchase agreement; do not leave it to the preparer's convention.

Second, UBIA transfers with the interest, but the rule is not intuitive. Under Treas. Reg. § 1.199A-2(c)(3), UBIA of qualified property is generally determined at the partnership level and allocated to partners under § 704(b). A § 743(b) adjustment to the basis of qualified property is treated as qualified property for § 199A purposes only to the extent the adjustment reflects an increase in fair market value. The effect: the incoming buyer with a § 754 step-up on depreciable fixed assets can generally include the step-up portion in their UBIA, which supports their own 199A deduction. A buyer whose 199A is wage-and-UBIA-limited (typical for real estate) should price this in.

Third, the SSTB problem. If the LLC is a specified service trade or business (health, law, accounting, financial services, consulting, and the rest of the § 199A(d)(2) list, as narrowed by Treas. Reg. § 1.199A-5), a buyer over the taxable-income threshold gets no 199A deduction at all on that income, and a buyer in the phase-in range gets a partial one. This materially affects the after-tax value of the interest. A professional-services LLC where both members are above the threshold is a different economic deal in 2019 than it was in 2017, and the sale price should reflect that rather than pretending the deduction is there.

What the operating agreement should already say

The Delaware LLC Act defaults have not moved. A member's interest is personal property under 6 Del. C. § 18-701, assignable under § 18-702 unless restricted (with economic rights only to an assignee absent consent), and a member cannot resign before dissolution unless the agreement permits under § 18-603. On a permitted resignation, the departing member gets what the agreement provides, or if silent, the "fair value of such member's limited liability company interest as of the date of resignation" under § 18-604. Charging orders remain the exclusive creditor remedy under § 18-703.

What a 2019 buyout clause should cover is the same list as 2017 with two additions. The triggering taxonomy, the valuation mechanism, the right of first refusal, the payment terms, the tax-structure language, and a mutual non-compete and release are the baseline. The additions:

A clause assigning who chooses the § 706 allocation method for the year of transfer, because QBI items now ride on it. And a clause on SSTB status, because the partnership's answer to "are we a specified service trade or business" (and if a non-SSTB trade or business is conducted by the same entity, whether the de minimis rules in Treas. Reg. § 1.199A-5(c)(1) are met) is a partnership-level characterization the departing member cannot unilaterally revisit after exit.

The 2019 checklist

Agree on structure, redemption or cross-purchase, before price. Run the § 743(d) substantial-built-in-loss test under the new transferee formulation. Decide the § 736(a)/(b) split and document it in the purchase agreement. Make the § 754 election, or confirm one is in force, on a timely-filed Form 1065 for the year of transfer, and allocate § 743(b) under § 755. Set the § 706 allocation method for the transfer year in writing, with 199A items in mind. Confirm SSTB status and the buyer's 199A posture before pricing. Update the operating-agreement schedule, the capital accounts, and the K-1s. Issue the check last.

Rule of thumb: in 2019, price the interest net of 199A, using the buyer's actual taxable-income posture and the partnership's SSTB characterization, because the deduction is now a real line item in the after-tax math and pretending otherwise transfers value from whichever side did not do the analysis.

Sources

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