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Entering a Partnership?

 By Brenden Cawley and Gabriel Jacobson 

 

The COVID-19 pandemic has caused several partnerships local to Western Mass. to either consider or actually effect a change in ownership. When navigating the complexities of these changes in ownership, partnership basis is a vital component.

For tax advisors and taxpayers alike, basis would be better as a four-letter word. However, understanding the basics of cost basis can prevent future headaches.

 

Understanding the Basics of Basis

It stands to reason that the cash spent or provided to acquire an asset would be the cost (basis) of that asset. However, when analyzing partnerships, understand the concepts of ‘inside’ and ‘outside’ basis. The difference is a shift in perspective. The outside basis is established when the partner joins or forms the partnership through the contribution of cash (or property, which adds additional complexity). The partnership then uses that cash to purchase assets.

The cash outlay to acquire those assets establishes the total inside basis of the partnership. Based on each partner’s ownership, a share of the inside basis of the individual assets is assigned accordingly. This inside basis does not fluctuate with changes in market value of the assets. When a tax year closes, the partners each receive a Schedule K-1 and adjust their outside basis by the income, expense, gain, or loss disclosed on the Schedule K-1.

Brenden Cawley

Brenden Cawley

“For tax advisors and taxpayers alike, basis would be better as a four-letter word. However, understanding the basics of cost basis can prevent future headaches.”

Over the life of the partnership, cash or property will be distributed to the partners, which will decrease their outside basis. The inside basis of the partnership will similarly be reduced as the cost of assets is removed from the books through sale or distribution. When the partnership is in need, the partners may contribute additional cash or property. Additional contributions have the same positive impact on outside basis as the initial contribution that formed the partnership or acquired an interest.

As time goes by, differences can arise between the inside and outside basis of the partner(s). As the inside and outside basis of the partnership fall out of alignment, the partners can experience negative tax consequences. Each taxpayer is responsible for maintaining their own outside basis, so consult your tax advisor if questions arise. Through a Section 754 election, the partnership has an opportunity to avoid these consequences.

Like anything worthwhile, this election takes work. It is perhaps especially laborious if the partner or partnership have not been actively tracking the inside and outside basis disparity. The partners’ Schedule K-1s could offer a lifeline. Prior to 2020, each partner’s capital account in item L could be prepared on a book, GAAP, Section 704(b), or tax basis. It is possible that the partner’s capital account prepared using book, GAAP, or Section 704(b) is a reasonable approximation for the inside basis of the partner.

This is a highly simplified approach that needs to be vetted with the partnership’s tax advisor. Starting in 2020, the IRS has mandated that Item L of Schedule K-1 must be prepared on a tax basis. The partner’s tax capital account is a good starting point for both outside and inside tax basis. Again, this simplified assumption needs to be discussed with a tax advisor. Please note that tax capital reported on the Schedule K-1 is not equivalent to outside tax basis. Instead, outside tax basis considers liabilities of the partnership for which the partner is individually responsible and partner-specific adjustments.

 

Everyday Example

In year one, Ann and Bob purchase a building for $200,000 and split the cost evenly, giving them each 50% ownership in ABC Partnership. Initially, they each had outside basis equal to their inside basis of $100,000. In year two, as a result of COVID-19, Bob wants to exit the partnership. The building has appreciated in value to $300,000, so he sells his interest in ABC Partnership to Carl for $150,000. Bob will recognize a $50,000 gain in year two as a result of the excess cash received compared to his cost basis.

First, let’s imagine the partnership does not make a 754 election at this point. Carl steps into Bob’s inside basis of $100,000. However, his outside basis equals the total amount he paid, or $150,000. In year three, Ann and Carl decide to sell the building (for simplicity’s sake, let’s assume no depreciation has been expensed), which is still valued at $300,000 and therefore results in a gain of $100,000. Both Ann and Carl receive Schedule K-1s with a $50,000 gain for the year because they both had an inside basis of $100,000 prior to the sale.

Gabriel Jacobson

Gabriel Jacobson

“Partnerships may be relatively easy to form, but the tax implications can be very complex.”

After recording the gain, their inside basis increases to $150,000. Ann’s inside and outside basis remain aligned, but Carl’s basis disparity persists as the $50,000 of gain impacts his inside and outside basis in the same manner. In year four, Carl and Ann decide to dissolve the partnership. At this point, the $300,000 cash they received from the sale of the building is distributed to both partners evenly. Ann receives $150,000 in cash, which equals her outside basis. For this reason, she recognizes no gain or loss on the dissolution of the partnership.

Alternatively, Carl recognizes a $50,000 loss outside of the partnership since his total outside basis is $200,000. At this point Carl is kicking himself because he paid taxes on a $50,000 gain in year three only to recognize a loss of $50,000 one year later. If Carl does not have any capital gains in year four, he can only utilize $3,000 of the capital losses on his tax return. The remaining losses are carried forward indefinitely.

Now let’s imagine the partnership made the 754 election when Carl purchased his 50% interest in year two. At that time, his inside basis would have been increased by $50,000 to match his outside basis. The partnership would have adjusted Carl’s inside basis in the building to $150,000, matching his outside basis. Then in year three, when Ann and Carl sell the building, Carl would not recognize any gain because his inside basis matches his share of the sales proceeds ($150,0000).

In year four, when the partnership dissolved, Carl would not recognize a loss on the distribution of cash from the partnership because his portion of the partnership’s cash balance ($150,000) equals his outside basis ($150,000). Carl avoided the timing issue regarding any taxable gain on the building sale and any loss on dissolution by making the 754 election.

 

On an Income-tax Return

If Carl and Ann decided to hold onto the building instead of selling in year three, Carl could deduct from his Schedule K-1 the basis adjustments related to the Section 754 election. The total Section 754 adjustment of $50,000 is reduced to zero over time using the same mechanics as the depreciation on the building. The 754 adjustment reduces both Carl’s inside and outside basis equally. The benefit is that he will receive deductions on line 13 of his K-1 against income on his tax return each year until the $50,000 is fully deducted.

Partnerships may be relatively easy to form, but the tax implications can be very complex. Section 754 is important for a partner purchasing an interest and for existing partners looking to secure a new partner to help their business. Accurate tracking of inside and outside basis is of the utmost importance to reduce negative tax consequences down the line.

 

Brenden Cawley is a senior associate at the Holyoke-based accounting firm Meyers Brothers Kalicka P.C., and Gabriel Jacobson is an associate with the firm; (413) 536-8510.

Banking and Financial Services

A ‘Natural Partnership’

Chris Milne, left, and Mike Matty both say the union of St. Germain and Gage-Wiley is a natural partnership.

Mike Matty says the talks with Chris Milne began roughly two years ago.

And as they often do in such cases, these discussions were somewhat intermittent in nature and came in varying degrees of intensity.

“With those first preliminary talks, you talk, then you stop talking about it for a little while, you revisit it … it’s been percolating for a while,” said Matty. “Half the time, it’s just … you grab dinner or you grab a beer and chat about business more than anything else, primarily because the companies are so similar and dealing with the same issues and you want to see how they’re dealing with these issues. And then, the talk would turn to ‘are we still thinking about this, or are we not thinking about this?’”

‘This’ was a proposed acquisition of Northampton-based Gage-Wiley & Co., which Milne served as president and CEO, by Springfield-based St. Germain Investment Management, which Matty has led for a number of years now. And eventually, the talk led to a deep dive and a decision to go forward.

The combined company has close to $2.4 billion in assets (Gage-Wiley had nearly $800 million), and four offices overall — St. Germain has a second office in Lee, and Gage-Wiley has a second office in Plymouth. This means it has much-needed size at a time of increased — and more complex — regulation, but also a small-enough size to remain nimble. Just as important, it now has nearly two centuries of time in the investment-management business.

Indeed, Matty joked that Gage-Wiley was a little on the young side in comparison to St. Germain, with the former being only 87 years old and the latter 96.

“I realize they’re a fairly new upstart, since they only started in 1933,” said Matty, who then turned serious and called this a “natural partnership.”

Natural because the companies are so similar — they both were started in Springfield, they’ve both remained locally owned and privately held, and they have similar operating philosophies.

Milne agreed. He actually initiated those talks two years ago, not thinking they might eventually lead to this union. Like Matty, he said the early discussion was focused on simply how to do business in a changing environment.

Eventually, though, it became clear that coming together made far more sense than staying apart and competing with each other.

“It’s a case where one plus one equals three,” said Milne. “It seemed like the right thing to do at the right time and for the right reasons; the similarities and compatibility were just too good not to get married.”

The name ‘Gage-Wiley’ will remain over the door of the facility in Northampton, and Milne will serve as managing director, because that brand is well-established, and it made no sense to change it, said Matty.

“I realize they’re a fairly new upstart, since they only started in 1933.”

“There’s a lot of good will built into that name and client relationships built up over time,” he told BusinessWest. “It’s very strong name, and we have no intention of disrupting things and taking all that away from them.”

Thus, in many ways, that office will operate much like October Mountain, St. German’s subsidiary in the Berkshires — a firm with its own name and its own staff, but with a bigger organization behind it.

“Very little, if anything, will change,” said Matty. “From the Gage-Wiley client standpoint, their statements look almost identical to the way they looked before — there just happens to be a new line that says ‘securities offered through St. Germain Securities’ on it. The phone number is the same, they’re talking to the same people … from the client standpoint, it will be almost invisible.”

Beyond the size and wealth of experience the combined firm now boasts, however, it also has what Matty described as a deeper pool of talent and expertise that it can bring to the table to better serve investment clients.

Elaborating, he said the teams at the respective companies bring experience in different areas that will complement each other effectively.

“We bring to the table for them a fixed-income expertise that they didn’t have, and we also bring more resources on compliance, legal matters, and human resources,” he explained. “And that comes with being a bigger company and having to tread these waters for a longer time with more people — we’ve had more experience at it.”

Meanwhile, Gage-Wiley brings different elements to the table, starting with some operational processes and ways of doing things that are in some ways better than those at St. Germain, Matty noted.

Gage-Wiley also brings an expertise in what is known as ESG (environmental, social, and governance) investing, a mindset that is growing in popularity, especially among the younger generations.

“Many people are looking to invest according to their ethics,” said Matty, noting that years ago the acronym for this philosophy was SRI — socially responsible investing.

But there is a difference, he went on, adding that SRI was mostly an exclusionary approach — ‘here’s what we’re not going to buy’ — while ESG is more of an inclusionary approach.

“People will say, ‘here’s a company I want to see a change at — I’m going to buy some of its stock, see if I can be a shareholder activist, and see if we can make some changes from within,’” he explained. “It’s a more comprehensive approach than the old SRI.”

And the team at Gage-Wiley, based in Northampton, has developed an expertise in this realm that St. Germain did not possess.

It does now, though, because of this ‘natural partnership’ that Matty described, one that brings nearly two centuries of local ownership together under the same umbrella — if not the same name and same roof.

As noted, this union gives the combined company more size and the important element of flexibility. But it also provides something else — stability and staying power during an ongoing time of consolidation within this industry.

“We’re going to stay independent,” Milne said. “And we’re now the perfect size — we’re not too big, and we’re not too small, and we’re not going anywhere.”

—George O’Brien

Features

Test Driving a New Model

Paul Mina

Paul Mina says the United Way of Pioneer Valley has to go back to basics in many respects, but it also has to do a lot of outside-the-box thinking.

Steve Lowell says he took the phone call back in early August; he doesn’t recall the exact date.

Everything else, though, he remembers quite clearly.

That’s because on the other end of the line was Paul Mina, president and CEO of the United Way of Tri County, who asked for a moment of Lowell’s time — and used it to get a whole lot more than that.

Mina was calling Lowell, president and CEO of Monson Savings Bank, and chairman of the board of the United Way of Pioneer Valley (UWPV), with a proposition of sorts, a unique partnership that has many potential — and, in some cases, already real — benefits for both United Ways.

That partnership comes in the form of a management agreement (two and a half years in length) whereby UWTC, as it’s called, will essentially share a CEO (Mina) with UWPV and handle backroom operations — bookkeeping, marketing, and others — for this region’s United Way for a percentage of the funds raised during its annual campaign.

This partnership, forged after several years of unsettledness at the top for UWPV — it has seen two CEOs and two interim CEOs since early 2016 — brings what Lowell called some “much-needed stability,” while also enabling UWPV to maintain its autonomy at a time when many such agencies are entering into mergers.

But it also gains much more, including perhaps $200,000 in savings on administrative costs and, even more importantly, a CEO with 30 years of experience working within the United Way family, said Lowell, adding that Mina brings a wealth of experience, and energy, to his expanded role.

“We needed some stability in the organization, and we needed a forward-looking, positive strategy,” he explained. “And in talking with Paul, our board of directors became convinced that he could do all that; he’s hit the ground running and done more in the month he’s been on board than I would have thought possible.”

Mina’s comments on his expanded duties and his approach to them echo those sentiments.

 

Steve Lowell

Steve Lowell

“We needed some stability in the organization, and we needed a forward-looking, positive strategy. And in talking with Paul, our board of directors became convinced that he could do all that; he’s hit the ground running and done more in the month he’s been on board than I would have thought possible.”

 

“I’m not a United Way CEO who hangs around and goes to meetings,” he told BusinessWest. “I’m a get-your-hands-dirty, fundraising person; I’m the chief fundraiser here, and I’m the chief fundraiser at our other office in Framingham, and I lead by example in that regard.”

By that, he meant that he’s generally not in his office at 1441 Main St. and is instead on the road, visiting area companies and stressing to decision makers that, while the times, and charitable giving habits, have changed, the United Way is still relevant, and it still plays a pivotal role within the community it serves.

“The first thing I said to everyone here in Springfield when we met on the first day was, ‘take your job descriptions and throw them out the window,’” he went on. “That’s because we’re all fundraisers, and that includes people who never leave this office.”

Such energy — and such a focus on fundraising — will certainly be necessary because, as most know, this United Way is much smaller (in every way) than it was a decade or even five years ago, especially when it comes to annual donations.

Indeed, this was a $5 million United Way — that’s the parlance used — earlier this decade, and is now closer to a $2 million agency. The loss of financial-services giant MassMutual as a major contributor — that corporation now gives back to the community through its own foundation — has been a major factor in the decline of the UWPV, but there are other factors as well.

These include changes within the business community, especially the smaller number of locally based banks and other types of companies, as well as those noted changes in how many individuals and businesses give back. Many now donate directly to a specific cause or charity, often through vehicles like the hugely successful Valley Gives program.

In response to these trends, and to bring its numbers higher, UWPV has to go back to basics in some respects, some Mina, and remind companies why it’s so important to support the United Way.

But it must also think outside the box, which in this case means beyond the traditional payroll-deduction model of giving back, as is the case with a new initiative called ‘Feed a Family,’ which invites individuals and businesses to donate specifically to the many food banks supported by the United Way (more on that later).

For this issue, BusinessWest looks at the new partnership arrangement, the projected benefits, and how the UWPV looks to capitalize on them.

When a Plan Comes Together

Summing up his first several weeks on the job, Mina said he’s on what he described as a ‘thank-you tour.’

By that, he meant he’s reaching out to many individuals who have been strong supporters of UWPV over the years, letting them know their support is certainly appreciated. He’s doing so, he said, because, due to all the transition in leadership in recent years, such acknowledgements have been somewhat lacking.

“We didn’t thank people enough — we didn’t honor people enough,” he told BusinessWest, adding quickly, “you can never thank people enough.”

Mina said that’s one of many lessons he’s learned over a more than 40-year career working for and behalf of nonprofits. It began with a lengthy stint as director of the Lincoln Square Boys Club in Worcester and, later, the Worcester Boys and Girls Club’s Camp Hargrove as well. He joined the United Way organization in 1988 as senior campaign fundraiser for the United Way of Central Mass., and in 1994, he became president of the United Way of Assabet Valley in Marlboro.

Since 1996, he’s led the UWTC, an entity created through the merger of several smaller United Ways based in Marlboro, Framingham, Norwood, Westborough, and Clinton — the three counties (actually parts of them) being Middlesex, Norfolk, and Worcester.

And since 2006, he’s also been president and CEO of Mass211, a program (a phone number, really) that connects callers to information about critical health and human services available in their community.

With these stops on his résumé, Mina is well aware of the many challenges facing United Ways across the country and across the region, especially the smaller organizations. Most all of them are looking for creative answers to the twin challenges of increasing revenues and reducing expenses.

It was with this thought in mind that a proactive Mina — aware that UWPV had launched a search to find a successor to Jim Ayers, who left his position as president and CEO to seek another opportunity, and looking for a way to help two United Ways — picked up the phone and called Steve Lowell.

“I said, ‘it’s very important that the western part of the state has an anchor United Way,’” he recalled, adding that he invited Lowell to breakfast to “hear him out.”

He agreed (Mina, Lowell, and Denis Gagnon, vice chair of UWPV, got together the next day, in fact), and Lowell recalls soon liking what he was hearing.

“He said that he might have a solution for a solution for our organization that would allow it to keep its autonomy and the local oversight we want, but also gain some efficiencies,” Lowell recalled, adding that, with that opening, he was all ears.

Fast-forwarding a little, the two sides worked out a proposal and took it back to their respective full boards. Mina said his board had a number of questions, which were answered sufficiently to garner a 17-1 vote to enter into the agreement. The vote was unanimous at the UWPV, which, said Lowell, viewed the partnership as the best possible path for the agency moving forward.

“This really benefits both organizations,” he told BusinessWest, adding that, beyond the help on the expense side of the budget, UWPV gains from Mina’s vast experience working for the United Way and guiding agencies through the recent whitewater.

“He has more than 30 years of United Way experience; he’s been through some tough times and been successful at turning them into positive situations,” Lowell said. “When you put it all together, it was a great solution for us.”

Shared Enthusiasm

Gagnon agreed with that assessment.

He noted that Mina and UWTC have a strong track record of bringing United Ways together in a merger, creating efficiencies, and providing ways for these agencies to carry out their missions effectively given the many challenges they’re facing.

This arrangement is not a merger, he said, stressing that point repeatedly, but the goals are similar, and so are the basic strategies for achieving them.

“We needed a new leader and a few other key staff members,” he said, noting that, with Ayers’ departure, there were some others as well. “The United Way of Tri County can provide that all in one shot, rather than have separate recruiting efforts.”

The plan is for Mina to spend half his week in Springfield and other half in Framingham, leading the UWTC, although he knows there will some weeks where he’ll be in one region more than the other. And these will certainly not be 40-hour weeks.

But will this arrangement work as intended for both agencies?

Those we spoke with are, as noted, certainly optimistic, and also convinced that this partnership is better than the alternative — hiring a CEO specifically for UWPV and keeping the backroom operations in Springfield, especially at this critical time for the organization — the middle of an all-important annual campaign.

More to the point, both United Ways need it to work and are committed to making it work, said Mina, noting that all United Ways are facing a host of challenges, including those mentioned earlier with regard to how people give and why.

Which brings him back to those notions of stressing the basics, but also thinking outside the box.

“People give through their heart to their head to their wallet,” he explained. “And we have to do a good job of telling people what happens when they contribute to the United Way. It’s not a right that we have that people give to us, it’s a privilege, and we have to prove that what we’re doing is valuable and that it helps improve quality of life for the people who live and work here.

“And in order to do that, you have to be able to show ROI,” he went on, “and you can’t do that if you’re not out in the community seeing what’s important and doing what’s necessary to be done.”

As an example of this, he noted the Feed a Family drive, which specifically targets food pantries and other agencies that help feed those within the community.

“At the United Way of Pioneer Valley, we have focused for decades on funding safety-net services that assist this very vulnerable population. One such service area is our food-security initiative where food pantries and congregate meal programs feed hungry individuals and families in our region,” he said, noting that last year, United Way- funded programs provided more than 251,000 meals in the Pioneer Valley.

“While that’s an impressive number, the need unfortunately continues to increase rapidly, and donations lag far behind,” he went on, adding that the initiative will directly support the Gray House, Home City Development Inc., Open Pantry Community Services, the Salvation Army, and the Springfield Rescue Mission (all based in Springfield), as well as Neighbors Helping Neighbors in South Hadley, Our Community Food Pantry in Southwick, and Providence Ministries for the Needy in Holyoke.

Bottom Line

The Feed a Family drive is, as Mina noted, somewhat outside-the-box thinking for this United Way, but something definitely needed amid these changing and very challenging times.

The same can be said for the management agreement between the UWPV and UWTC. It is something different, but also something both boards deemed ultimately necessary — not just for this area’s United Way, but for both agencies.

Rather than an act of desperation, Mina called it “an act of intelligence,” and he credited both boards for having the imagination, and good sense, to make it happen.

Will it work? Time will tell, but so far the arrangement has generated what its architects hoped it would — stability and optimism.

George O’Brien can be reached at [email protected]

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