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Abstract: 

For a service partner with a profits interest and a significant guaranteed payment, the absence of an interest in losses can generate significant partnership tax redetermination risks. A potential negative capital account variable can mitigate those risks, however, by reducing the viability of an IRS redetermination of the service partner’s profits interest as service provider compensation, a guaranteed payment, or a disqualified tax-gaming special income allocation. In short, pass-through capital gain treatment can be protected by some measure of capital account risk. This article is relevant to anyone with a service partner compensation package involving both a profits interest and significant guaranteed payment, and is particularly relevant to the financial services sector’s often-used two and 20 carried interest and management fee compensation package.

Keywords: carried interests; profits interest; two and 20 compensation package; service partner interest; IRS redetermination

Affiliations:  1: Villanova University School of Law Graduate Tax Program.