Insight Alert: Profits Interests Ruling
The U.S. Tax Court recently examined the definition of a “profits interest” in ES NPA Holding, LLC v. Commissioner (TC Memo 2023-55). The decision provides support to issuers of profits interest, including those in the real estate industry.
IRS Revenue Procedure 93-27 provides a safe harbor rule for the definition of a “profits interest.” It defines a profits interest as a partnership interest rather than a capital interest that would give the holder a share of the proceeds if the partnership assets were sold at fair market value and the proceeds were then distributed in complete liquidation. In addition, a profits interest can be provided for services to or for the benefit of a partnership and the individual’s capacity as a partner in anticipation of becoming a partner. Generally, profits Interests are not taxable on receipt, provided they do not (1) relate to “substantially certain and predictable steam of income”; (2) are held for at least two years prior to disposition; and (3) are not granted by a publicly traded partnership.
The IRS has taken the position that the taxpayer in ES NPA Holdings, LLC, could not benefit from the safe harbor of Rev. Proc. 93-27 because the taxpayer did not provide services to the issuing partnership but rather to a lower-tier partnership.
The Tax Court reading Rev. Proc. 93-27 expansively held in favor of the taxpayer, provided that the taxpayer receives a profits interest issued out of the partnership in consideration of the services that were, among other things, for the benefit of another partnership may qualify for the safe harbor.
The result of this case should be further proof that the grant of a profits interest to a lower-tier partnership, including those issued on a back-to-back basis, fall within Rev. Proc. 93-27. Again, the applicable profits interest would be based on the profits of the lower-tier partnership only. We continue to recommend that taxpayers consider filing Section 83(b) election for the grant of the profits interests if it is subject to a substantial risk of forfeiture.
Phil Jelsma, a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLP (CGS3), takes a look at the U.S. Tax Court’s recently issued memorandum opinion in an article published in The Daily Journal (subscriber only).