If an established LLC business offers ownership to a new member, will that member owe federal tax even though that member has still not realized any gain?

Let's say for example the LLC is worth $10M USD, and the new member gets 10% of the company, i.e. $1M USD. Assuming this person is on the top bracket 33%, will he need to pay ~300K USD?

Does anyone understand this process?


It really depends. If it is offered as compensation (ie in leiu of, or in addition to salary or cash bonus) then it would be reportable income, and if sold later for a profit then that would be taxable as gains. If this share is purchased as an investment at current value then it would be treated like other securities most likely gains realized at sale. Any discount could be considered income but there are some goofy rules surrounding this enacted to prevent tax evasion and some to spur growth. That is the answer in a nut shell. It is far more complicated in reality as there are somewhere around 2000 pages of regulations deal with different exceptions and scenerios.

  • 2
    Good answer. Just to expand: no gain or loss is generally recognized by a partner when property is contributed to an LLC (or any partnership in general). There are generally 2 situations where gain must be recognized by the partner: 1) when services are rendered in exchange for a share (reportable income is equal to the value of the share received); and 2) when there is a liability attached to the property contributed (reportable income equal to the debt attached to the property).
    – Daniel
    Feb 24 '12 at 16:56
  • Thanks Chad and Daniel. I understand the difference, my question is. If that person gets involved as a partner, he receives a salary for his role, and he receives the participation of the LLC as a key player. The LLC group wants to give that participation to this new member. The new member pays the tax related to that participation. Two years down the road, the member wants to sell his participation. Could the LLC say, we don't have enough to buy your participation? This is assuming the LLC is growing and doing good.
    – Geo
    Feb 24 '12 at 17:46
  • @Geo - Unless there is something in the contract that says the LLC will buy back the participation then yes. If it is in the contract then what the contract says generally goes unless the contract conflicts with the law. I would want a lawyer to read your contract to tell you for sure how it would work.
    – user4127
    Feb 24 '12 at 17:58

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