IRS Clarifies Rev. Proc. on Partnership Interest for Services

R ev. Proc. 2001-43 addresses the treatment of a grant of a substantially nonvested profit interest for services, clarifying Rev. Proc. 93-27. Under Rev. Proc. 93-27, the grant of a partnership profits interest for services is generally not taxed to the service provider, but the grant of a capital interest for services is. The time for determining whether a profits or capital interest has been granted is the time of receipt. The testing date for substantially nonvested profits interests has been unclear. Under Rev. Proc. 2001-43, the taxability of a receipt of a substantially nonvested profits interest is determined at the same time as a vested profits interest (i.e., at the time of receipt) if the taxpayer satisfies three requirements.

Practitioners have questioned whether the safe harbor in Rev. Proc. 93-27 applied to a receipt of a substantially nonvested profits interest. Rev. Proc. 2001-43 treats the grant of this interest just like a grant of a vested profits interest, if (1) the partnership and service provider treat the latter as a partner from the grant date of the substantially nonvested profits interest, (2) no one takes a deduction for such interest and (3) the taxpayer satisfies the Rev. Proc. 93-27 requirements. Service providers subject to Rev. Proc. 2001-43 do not have to file Sec. 83(b) elections.

Rev. Proc. 93-27 defines a profits interest as an interest other than a capital interest. A capital interest is defined as an interest that gives the holder a right to proceeds on liquidation of the partnership. The receipt of a capital interest for services is taxable, according to Rev. Proc. 93-27. The time for testing whether an interest is a profits or capital interest is the time of the receipt of the partnership interest. Under Rev. Proc. 2001-43, the Service treats a person receiving a substantially nonvested profits interest as receiving the interest on the grant date if that person satisfies the three requirements. Thus, the time for testing whether a substantially nonvested profits interest is a profits interest or capital interest under Rev. Proc. 93-27 is the grant date if the person meets the three requirements. The IRS and Treasury have not clarified whether a person receiving a substantially nonvested profits interest without satisfying the three requirements will be treated as receiving a capital (rather than a profits) interest.

By Jeffrey A. Erickson, J.D., Washington, DC