Lewes CPA
officeProgar & Company, P.A.
Certified Public Accounting services for businesses and individuals
Receiving partnership interest in exchange for services (MS Word)
Receiving partnership interest in exchange for services (.pdf)
Receiving partnership interest in exchange for services
Dear Reader:
You recently mentioned that you expect to receive a partnership
interest in the firm in which you are currently employed in exchange
for your services. This letter will explain the tax implications of
the receipt of the partnership interest in exchange for your
services.
A partnership interest can be divided between an interest in the
capital of the partnership and an interest in the future profits of
the partnership. The tax law provides that a person who receives an
interest in a partnership's existing capital in exchange for
services recognizes income at the time of the receipt of the
interest. In contrast, IRS has announced that it will generally not
treat the receipt of an interest in the future profits of a
partnership (other than a publicly traded partnership) as taxable,
unless the profits are substantially certain (e.g., the partnership
holds treasury bonds on which it receives a predictable income
stream) or the partner disposes of the profits interest within two
years of the receipt of the interest.
You have informed me that the partnership will be giving you a
profits interest and that you will have to “buy in” to get an
interest in partnership capital by reducing the distributions you
will receive. For instance, if your interest in partnership profits
for next year will be $150,000, you will receive distributions of
$125,000, and a $25,000 interest in partnership capital. The
reductions in the distributions you receive will continue until your
percentage interest in partnership capital is equal to your profits
percentage.
In this situation, you will not recognize any income as a result of
your receiving the profits interest, since the profits are not
substantially certain and you cannot dispose of the partnership
interest. Accordingly, you will not be subject to tax as a result of
your receipt of the profits interest. However, because your
distributions will be reduced as a result of the “buy in,” you will
be subject to tax on profits that exceed your distributions.
We can discuss with you the implications of the “buy in” and help
you negotiate terms with the partnership that would make it easier
for you to avoid any cash flow problems resulting from the “buy in.”
If you would like our help in considering the terms of your entry
into the partnership or would like to discuss this topic further,
please give us a call.