## Facts

- Crescent Holdings, LLC (Holdings) was formed in 2006 as an LLC taxed as a partnership; Crescent Resources, LLC (Resources) was an operating entity whose ownership was transferred to Holdings.
- Resources entered an employment agreement with Arthur W. Fields under which Holdings would transfer Fields a 2% interest in Holdings if Fields served as CEO of Resources for three years.
- The promised 2% interest was nontransferable and subject to a substantial risk of forfeiture until the service period was completed.
- For 2006 and 2007, Holdings allocated partnership items attributable to the 2% interest to Fields and issued Schedules K-1 reflecting those allocations, though Fields did not receive corresponding distributions.
- Fields and his spouse reported the allocations in gross income, and Holdings made payments intended to cover Fields’s resulting tax liabilities.
- Fields resigned before completing the service period and forfeited the 2% interest before it vested; Holdings sought repayment of the tax-reimbursement payments.
- The IRS issued FPAAs for 2006 and 2007 determining Fields should be treated as a partner and taxed on the undistributed allocations attributable to the 2% interest.
- Fields filed TEFRA petitions as a partner other than the tax matters partner; the cases were consolidated, and a partner (Duke Ventures) intervened supporting the IRS position.

## Issues

1. Whether the promised, nonvested 2% partnership interest was a partnership capital interest or a partnership profits interest.
2. Whether I.R.C. § 83 applies to a nonvested partnership capital interest transferred in connection with services, and how income is treated while the interest remains subject to a substantial risk of forfeiture.
3. Whether the service provider or the other partners must recognize undistributed partnership allocations attributable to the nonvested interest for the years before forfeiture.

## Decision

- The Tax Court held the 2% interest was a partnership capital interest, not a profits interest.
- The court held Rev. Proc. 93-27 and Rev. Proc. 2001-43 were inapplicable because they address only profits interests.
- The court held I.R.C. § 83 applies to the transfer of a nonvested partnership capital interest in exchange for services.
- Applying Treas. Reg. § 1.83-1(a)(1), the court held that, while the capital interest remained substantially nonvested, the income attributable to it was includible by the transferor rather than the service provider.
- The court identified Holdings as the transferor of the 2% interest; therefore, the allocations associated with the 2% interest for 2006 and 2007 were allocable to the partners holding the remaining interests in Holdings, not to Fields.
- The court entered decision for the taxpayer, rejecting the Commissioner’s adjustments allocating the disputed amounts to Fields.

## Legal Principles

- A partnership capital interest generally entitles the holder to a share of partnership assets upon a hypothetical liquidation immediately after grant; a profits interest generally provides only a right to future profits and appreciation.
- Rev. Proc. 93-27 and Rev. Proc. 2001-43 provide administrative guidance for profits interests and do not govern transfers of capital interests.
- A nonvested partnership capital interest transferred for services is “property” within the scope of I.R.C. § 83.
- Under Treas. Reg. § 1.83-1(a)(1), when substantially nonvested property is transferred in connection with services, income attributable to that property is included in the transferor’s income until the property becomes substantially vested (or is otherwise transferred).
- For § 83 purposes, identifying the correct “transferor” determines who bears tax on pre-vesting income attributable to the nonvested interest.

## Conclusion

The Tax Court treated Fields’s promised 2% interest as a nonvested capital interest subject to § 83, requiring that undistributed allocations attributable to the interest during the nonvested period be taxed to the transferor (Holdings and thus its existing partners), not to Fields, particularly where the interest never vested and was forfeited.


Crescent Holdings, LLC v. Comm’r, 141 T.C. 477 (2013)