By Brandon Fredericks, CPA | AGP Advisory, Leader
Pass-through entities possess many important tax advantages, which include the ability to avoid double taxation and the Qualified Business Income deduction. However, the tax code contains several added complexities and potential tax pitfalls for ill-planned pass-through transactions. One such scenario involves “cash waterfalls” where distributions deviate from the proportion of equity contributed by each partner.
Business partners often arrange cash waterfalls to properly compensate the partners for their involvement in the transaction but aren’t aware of the potential tax implications they could face down the road. Income can become allocated in a manner not consistent with the allocation of cash flows from the business. In other scenarios, the tax code requires the suspension of losses or imposes capital gains taxes on distributions. Consequently, partners face tax bills they did not anticipate at the transaction’s closing.
Through proper planning during the transaction due diligence process, partners can prepare and potentially avoid the pitfalls associated with their cash waterfall. The tax professionals at Apple Growth Partners can review the unique details of your transaction and determine what tax issues the business may face in the future. Accordingly, a strategy can be formulated to mitigate any potential issues and maximize after-tax returns for all partners.
Many business owners find thorough planning a sound investment to avoid unexpected tax bills in the future. If you are contemplating purchasing or expanding a business, contact Apple Growth Partners today to create a tax plan for your transaction.