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Selling an interest in an LLC is not like selling stock in a corporation. The sale of corporate stock is taxed entirely at capital gains rates, plus, in some cases, the additional tax on net investment income. A sale of an interest in an LLC will, however, almost always result in a mix of capital gains and ordinary income. This can present a potential trap, especially for partnerships or LLCs (in particular professional service businesses) that have cash basis receivables.

The Fifth Circuit (affirming a Tax Court decision) reminded us of an additional issue in a case decided last month. In Mingo v. Commissioner, No. 13-60801 (5th Cir. 2014), the taxpayer sold her interest in a partnership (a large accounting firm) in exchange for a note. Normally taxpayers can report gain from a sale of property on the “installment” basis, not recognizing gain until the note (or some portion thereof) is actually paid. While it is clear that the portion of the sales price attributable to the accounting firm’s accounts receivable would generate ordinary income, what was less clear is that this amount could not be deferred using installment sale treatment. Therefore, the taxpayer had to include all of the income attributable to receivables on her tax return for the year of the sale, at ordinary income tax rates.

This treatment would apply to any member of a professional service partnership or LLC selling their equity interest in exchange for a note. Care should therefore be taken in selling any such interest, in particular those businesses with large unrealized receivables.