Business partnerships don't last forever. When you create a limited liability company, it's common to draw up an agreement for what happens if one owner wants out. The buyout agreement may require the departing owner to sell to her partners. With an interest redemption agreement, the LLC itself buys back the owner's stake.
How Redemption Works
When a partner sells to the remaining owners, they pay him out of their own pockets. Under an interest redemption agreement, the LLC pays -- out of earnings or by borrowing against assets, for example. The remaining owners may find this more affordable than buying the departing partner's interest themselves, and it gives them the same control of the ex-owner's share.
Redemption Tax Advantages
Redemption agreements may give the remaining owners a better deal on taxes by avoiding "technical terminations." If more than 50 percent of the LLC gets sold within 12 months, the IRS treats the company as if it dissolved and re-formed. If the LLC claims depreciation of assets as a business expense, this technical termination reduces how much depreciation is deductible. Interest redemption doesn't trigger this rule, so the depreciation write-off stays the same. Another advantage is that the LLC may be able to deduct some of the payments to the former partner as a business expense.
Departing Partner Benefits
The departing partner may get a better tax deal with redemption, depending on the company's assets. If the LLC owns inventory, accounts receivable or depreciable real estate, the departing partner's income from the buyout may fall under special tax rules. The rules can lead to steep taxes if the partner sells her interest, but not if the LLC redeems it.