## Facts

- The Internal Revenue Service issued an administrative safe harbor addressing federal income tax treatment when a person receives a partnership interest for performing services to or for the benefit of a partnership.
- The guidance responded to uncertainty and litigation over whether receipt of a partnership *profits interest* is taxable upon grant under I.R.C. §§ 61, 83, and 721.
- The guidance distinguishes between:
  - A *capital interest*: an interest that would receive a share of liquidation proceeds if partnership assets were sold for fair market value and distributed at the time of receipt.
  - A *profits interest*: any partnership interest other than a capital interest.
- The IRS reaffirmed existing regulatory treatment that receipt of a partnership capital interest for services is taxable compensation.
- The safe harbor is limited by specified situations where a profits interest may have readily determinable value or be easily monetized.

## Issues

1. When will the IRS treat the receipt of a partnership profits interest for services (in a partner capacity or in anticipation of becoming a partner) as not giving rise to a taxable event for the service provider or the partnership?
2. What exceptions prevent use of the nonrecognition safe harbor for a purported profits interest received for services?

## Decision

- The IRS stated it will not treat the receipt of a qualifying partnership profits interest for services as a taxable event to either the service provider or the partnership.
- The safe harbor does not apply if:
  - The profits interest relates to a substantially certain and predictable stream of income from partnership assets.
  - The recipient disposes of the profits interest within two years of receipt.
  - The profits interest is a limited partnership interest in a publicly traded partnership within the meaning of I.R.C. § 7704(b).

## Legal Principles

- A partnership capital interest received for services is taxable as compensation.
- A profits interest is determined by exclusion: it is any partnership interest that is not a capital interest (i.e., does not entitle the holder to current liquidation value at the time of grant).
- Under the safe harbor, receipt of a qualifying profits interest for services performed in a partner capacity (or in anticipation of becoming a partner) is generally treated as non-taxable at grant to both the recipient and the partnership.
- The safe harbor is unavailable where the interest is economically similar to a near-cash or readily valued right (predictable income stream), is quickly monetized (two-year disposition), or is in a context with market liquidity and pricing (publicly traded partnership interests).

## Conclusion

The revenue procedure establishes an IRS safe harbor under which a service provider’s receipt of a partnership profits interest is generally not taxed on receipt, while preserving taxation of capital interests for services and denying safe-harbor treatment in three specified situations indicating determinable value or monetization potential.


Rev. Proc. 93-27, 1993-2 C.B. 343 (1993)