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Sunday, September 11, 2016

Article Abstract: Carried Interests and Tax Treatment of Fee Waivers: an Attempt at Reform in the Proposed Regulations

TITLE

Carried Interests and Tax Treatment of Fee Waivers: an Attempt at Reform in the Proposed Regulations

AUTHOR(S)

William M. Funk

PUBLICATION

Business Entities, July/August 2016

PUBLISHER

WG&L

ABSTRACT (Key Points & Discussions)

    • Managers of investment partnerships regularly attempt to structure their carried interests so as to be nontaxable upon issuance, and to avoid ordinary income treatment on partnership allocations and distributions relating to those partner interests. In so doing, they seek treatment as regular partners on distributions under Code §§704/731, and they seek to avoid treatment as interests received by a non-partner under Code §707(a) or as a guaranteed payment under Code §707(c).
    • Fund managers are often paid under a bifurcated regime, such as the 2-and-20 arrangement. Under that arrangement, the manager will receive a fixed fee, such as a 2% of value under management fee, and a share of profits, such as a 20% profits interest. These arrangements sometimes allow the manager to forgo payment of the 2% fixed fee and instead effectively exchange that fee for an additional profits interest beyond the 20%.
    • The article reviews and analyzes Proposed Treas. Regs. §1.707-2, which regulations seek to provide more certainty in regard to whether partnership interests issued for services, such as carried interests, will be taxable under Code §§704/731.
    • The article then addresses the particular question of how the conversion of a 2% fix management fee into an additional share of profits by the manager will be taxed. Its conclusion is that if properly structured  (A) taxation of income allocated to and distributed to the partner on the newly issued profits interest will be treated as regular partnership transactions including under Code §§704/731, and not under Code §§707(a) or §707(c), but nonetheless (B) the exchange of the 2% fixed fee for an additional profits interest is taxable - principally because there is an ascertainable value of the additional profits interest team received (as measured by the fixed fee being foregone), in contrast to what was likely the initial nontaxable issuance of the initial 20% profits interest.

RESEARCH TAGS

Partnerships, carried interest, guaranteed payments, Code §§704, 707(a) & (c), 731.

MY COMMENTS

These new proposed regulations were issued in 2015.

 

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