Need help figuring out how my business partner will be taxed.

[Bob Jones]

Hi,

I have a business partner who has provided money to my LLC, which I will use to invest in real estate. The agreement is that I will do the work and give them a percentage of the profits. I'm trying to figure out how they are going to be taxed.

When I give them money, are they just going to pay basic income tax? Will they be subject to self employment tax? I may be engaging in seller financing. If this is the case, they will be receiving monthly payments from my LLC. Would this money be subject to capital gains tax?

[Eamonn McElroy]

@Michael Plaks

For #1, I'm saying merely not mentioning losses when they agreed to this venture does not negate partnership treatment.  Most first or second time joint ventures do not mention losses.  After all, who would enter into a venture if it's expected to lose money?

The IRS link while helpful to provide general information is not authoritative as I'm sure you're aware, and should be read in this context.

The statutory guidance on what constitutes a partnership is vague.  Instead we have to look to court precedence.

The courts have found that whether a venture is a partnership and subject to Subchapter K is "essentially a question of fact".

The Culbertson (49-1 USTC ¶9323) and Tower (46-1 USTC ¶9189) cases are the most frequently referenced here.

For #2, I'm not an attorney so I can't point to any law or statue regarding what's required in loan docs.

I think you'll have an uphill battle arguing the money is debt and not equity.  They intended to share in the profits of this new property.  What you're describing is some kind of perpetual, non-callable debt that doesn't have a stated interest or discount, doesn't obligate the debtor to make payments, and allows the debtee to share an agreed upon percentage in the profits of the property.  That sure sounds a lot like equity doesn't it?  : )