Maxwell Dent, Karla Fry, and Charles Cain, all expert jewelers, operate Adriano’s, a small jewelry business. They each own interests as members of Adriano’s LLC. Adriano has elected to be taxed as a partnership for tax purposes and its Form 1065s report Maxwell, Karla, and Charles as its partners. Maxwell, the key partner behind the business, owns 50% of the partnership’s capital and profits; Karla and Charles each own 25% of the partnership’s capital and profits. The partnership buys a substantial amount of loose stones (diamonds, rubies, and sapphires), as well as gold and silver, for resale (in a raw material form) in the market. The partnership also makes jewelry and sells the finished pieces at retail. At any given time, the partnership carries a substantial inventory both in raw materials and finished pieces. The partnership employs eight people who make and sell the jewelry.

Maxwell has given 25% of his ownership in the partnership to his older son, Bucky. Bucky is capable of performing some of the easier tasks (cleaning the stones, seeing the customers, etc.) but lacks the skills to make or repair the jewelry. Maxwell has admitted privately to Karla that the sole purpose of the gift was to ensure that Bucky has a steady income source and to have the income taxed in a lower tax bracket since Bucky is in the lowest tax bracket.

After this gift to Bucky, but before the tax year-end, your firm has been employed by Adriano as its accountant. You have also been informed that Maxwell would like to amend the operating/partnership agreement to grant Maxwell, as majority partner, the power to prevent distributions to Bucky and to prevent Bucky from selling his interest(the “Amendment”). Finally, you have been made aware that Maxwell in the past has been made a guaranteed payment of $50,000 each year in exchange for his services in managing the firm. Henceforth Maxwell intends to waive his fee so that more income will be allocated to Karla, Charles, and Bucky. You assume that the LLC’s bottom-line income for this year without Maxwell’s typical payment for his services will be $150,000. Prepare a tax research memorandum to the client file and a letter to Maxwell, Karla, Charles, and Bucky addressing (a) whether Bucky will be treated as a partner for tax purposes without the Amendment; (b) whether the Amendment will have an effect on Bucky’s tax treatment; and (c) assuming that Bucky is respected as a partner how will the income be allocated if Maxwell is not paid the typical $50,000 for his services.