May 30, 2023

Volume XIII, Number 150


May 29, 2023

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Tax Court Decision Interprets Profits Interest “Safe Harbor” under IRS Rev. Proc. 93-27

The Tax Court’s May 3, 2023, decision in ES NPA Holding, LLC v. Commissioner (T.C. Memo 2023‑55), upholding a taxpayer’s position to characterize a partnership interest as a profits interest under the “safe harbor” of IRS Revenue Procedure 93-27 (as clarified by IRS Revenue Procedure 2001-43), provides helpful guidance to issuers of profits interests, including private equity funds and other investment partnerships and their portfolio companies.

As background, Revenue Procedure 93‑27 provides a “safe harbor” definition of a profits interest. Specifically, it defines a “profits interest” as a partnership interest other than a “capital interest,” meaning “an interest that would give the holder a share of the proceeds if the partnership’s assets were sold at fair market value and then the proceeds were distributed in a complete liquidation” at the time of receipt of the partnership interest. It further provides that the receipt of a profits interest in exchange for services “to or for the benefit of” a partnership in the recipient’s capacity of a partner or in anticipation of becoming a partner is not a taxable event to the recipient so long as the profits interest (1) does not relate to a “substantially certain and predictable stream of income,” (2) is held for at least two years prior to disposition, and (3) and is not granted by a “publicly traded partnership.”

In this case, the IRS took the position that (a) the partnership interest received by the taxpayer did not qualify for the Revenue Procedure 93‑27 “safe harbor” and further did not qualify as a “profits interest” because the taxpayer did not directly provide services to the issuing partnership of the partnership interest and (b) the partnership interest was a capital interest rather than a profits interest because the taxpayer would be entitled to a share of the partnership’s proceeds in a hypothetical liquidation on the day the taxpayer received the partnership interest.

In its decision, the Tax Court—interpreting Revenue Procedure 93‑27 expansively rather than literally—held in favor of the taxpayer with respect to both of the IRS’s positions and provided that (1) a taxpayer who receives a profits interest issued out of one partnership in consideration of services that were, among other things, to or for the benefit of another related partnership—may, under the appropriate facts, qualify for the “safe harbor” and (2) a contemporaneous arm’s-length transaction was acceptable evidence of value for purposes of determining that the profits interest entitled the taxpayer to distributions out of post-grant profits only, and the partnership interest was therefore a profits interest rather than a capital interest. The Tax Court further stated that “[it does] not view Revenue Procedure 93‑27 in such a restricted manner, but rather view[s] [Revenue Procedure 93‑27] as administrative guidance on the treatment of the receipt of a partnership profits interest for services.”

While the Tax Court’s decision can be interpreted as being generally consistent with market practice, there are meaningful nuances to the Tax Court’s decision. In light of these nuances, and the general lack of interpretive guidance regarding profits interests, it remains important for issuers of profits interests to discuss their specific circumstances with their legal and tax advisors.

© 2023 Proskauer Rose LLP. National Law Review, Volume XIII, Number 143

About this Author

Michael Album Employee Benefits Lawyer Proskauer

Michael J. Album is a partner in the Employee Benefits & Executive Compensation Group, and represents companies and compensation committees, private equity firms and hedge funds, and CEOs, senior executives (in numerous business sectors) and portfolio managers on a full range of executive compensation matters. As part of his practice he has represented management teams in numerous management buy-outs (including in the health care, retail and asset management sectors) and has represented “founders” and partners in a variety of businesses on restructuring and “business...

Employment lawyer, Proskauer, Ekaterina (Kate) Napalkova
Special Employee Benefits and Executive Compensation Counsel

Kate Napalkova is a special employee benefits and executive compensation counsel in the Tax Department and a member of the Employee Benefits & Executive Compensation Group.

Kate advises public and private companies, private investment funds, executives and boards on a broad range of compensation and employee benefits matters. Kate’s practice includes the compensation and employee benefits aspects of mergers and acquisitions, reorganizations, spin-offs, initial public offerings, financings and other corporate transactions. Kate’s practice further focuses on advising clients...


David Teigman is a partner in the Tax Department and a member of the Employee Benefits & Executive Compensation Group. David focuses his practice on executive compensation and benefit matters, principally in connection with mergers and acquisitions, securities offerings and senior executive employment relationships.

David regularly counsels public and private companies on compensatory and benefit arrangements, such as equity-based incentives, cash-based incentives and employment, change-in-control, retention, separation and consulting...

Senior Counsel

Nicholas LaSpina is a senior counsel in the Tax Department and a member of the employee Benefits & Executive Compensation Group.

Tyler Forni Tax Attorney

Tyler Forni is an associate in the Tax Department and a member of the Employee Benefits & Executive Compensation Group.


Tax, Employee Benefits & Executive Compensation


New York University School of Law, LL.M., 2016
Chicago-Kent College of Law, J.D., 2015 cum laude
University of Massachusetts, Amherst, B.A., 2012 cum laude

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