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Taxing Risky and Non-Risky Compensation: Section 707(a)(2)(A)  

Author:  Karen C. Burke.

Source: Volume 33, Number 04, Summer 2016 , pp.3-34(32)

Journal of Taxation of Investments

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Proposed regulations have recently been issued to clarify the operation of Section 707(a)(2)(A), enacted more than 30 years ago. The proposed regulations are aimed primarily at abusive private equity management fee waivers but potentially affect other nonabusive transactions. This article considers the background of Section 707(a)(2)(A) as an anti-abuse provision and the proposed clarification of the entrepreneurial risk approach. The proposed regulations offer a relatively painless method of avoiding Section 707(a)(2)(A) if the service provider is willing to agree to a socalled “clawback obligation,” a common feature in private equity arrangements. The article illustrates the operation of the clawback mechanism in a deal-by-deal carried interest arrangement using target allocations. Despite Treasury’s broader regulatory authority to address capital gain conversion, the proposed regulations suggest that reform may yet again bypass carried interests.

Keywords: profits interests, management fee waivers, entrepreneurial risk, clawbacks, target allocations, private equity, disguised payments for services, IRC Sec. 707(a)(2)(A)

Affiliations:  1: University of Florida Levin College of Law.

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