Rev. Proc. 2001-43 Clarifies Treatment of a Grant of Substantially Nonvested Partnership Profits Interest

In Rev. Proc. 2001-43, the IRS provides guidance on the treatment of the grant of a substantially nonvested partnership profits interest to a service provider. The new procedure clarifies Rev. Proc. 93-27, by addressing the impact of vesting on the receipt of a partnership interest. According to Rev. Proc. 2001-43, the Service would not treat the grant of such an interest (or an event that causes such an interest to become substantially vested) as a taxable event for the partner or the partnership if the requirements of the new revenue procedure and Rev. Proc. 93-27 were met.

When Is an Interest Taxable?

According to Rev. Proc. 93-27, unless otherwise provided, if a person receives a profits interest for the provision of services to (or for) the benefit of a partnership in a partner capacity or in anticipation of being a partner, the IRS will not treat the receipt of the interest as a taxable event for the partner or the partnership. For this purpose, a "profits interest" is a partnership interest other than a capital interest, and "capital interest" is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value (FMV) and the proceeds distributed in a complete partnership liquidation. The determination as to whether an interest is a profits interest or a capital interest generally is made at the time of receipt of the partnership interest.

Rev. Proc. 93-27 did not address the impact of the vesting of a partnership interest. Consequently, Rev. Proc. 2001-43 clarifies that the determination of whether an interest granted to a service provider is a profits interest is, under the circumstances described, tested at the time the interest is granted, even if, at that time, the interest is substantially nonvested (within the meaning of Regs. Sec. 1.83-3(b)). Under Rev. Proc. 2001-43, a service provider would be treated as receiving the interest on the date of grant (and neither the grant nor the event that caused the interest to become substantially vested would be a taxable event for the partner or the partnership) if:

1. The partnership and the service provider treated the service provider as the owner of the partnership interest from the date of grant, and the service provider took into account the distributive share of partnership income, gain, loss, deduction and credit associated with that interest in computing its income tax liability for the entire period during which it had the interest;

2. On the grant of the interest or at the time it became substantially vested, neither the partnership nor any of the partners deducted any amount (as wages, compensation or otherwise) for the FMV of the interest; and

3. All other conditions of Rev. Proc. 93-27 were satisfied.

Unresolved Issues

The guidance leaves numerous issues unresolved, such as:

• Whether the revenue procedures apply if a service provider contributes capital to the partnership in exchange for a capital-and-profits interest and also receives a profits interest for services; and
• The consequences of a subsequent forfeiture of a profits interest.

From Natalie Weis, CPA, and Bill C. Wilson, CPA, Washington, DC, and Eric Sloan, J.D., LL.M., Washington, DC, and New York, NY