By: Richard Lieberman, Dykema Gosset PLLC

This article addresses fundamental considerations in structuring equity compensation for general and limited partnerships, as well as limited liability companies (LLCs) that are classified as partnerships for federal income tax purposes.

IT SUMMARIZES THE EQUITY-BASED ARRANGEMENTS USED by entities taxed as partnerships to provide key service providers the opportunity to become true equity owners of the business. (Synthetic equity arrangements, such as phantom equity and other cash-settled programs linked to equity appreciation, are not discussed here in detail.)

For simplicity, although this article generally uses the term partnership, the information is equally applicable to all entities classified as a partnership for federal income tax purposes, including general partnerships, limited partnerships, and LLCs.

Special Partnership Compensation Considerations

There are several issues that are important to understand when advising clients on equity compensation matters for partnerships. Many of these issues are unique to partnership equity compensation, primarily because of the different tax regime applied to entities taxed as partnerships compared to entities taxed as corporations. For tax purposes, a partnership is a pass-through entity, meaning that income tax is generally not imposed at the entity level. Instead, a partnership’s income, gain, loss, deduction, or credit (tax items) are allocated to its partners based on a method agreed to among the partners in the partnership agreement. The partners are liable for paying income tax on their distributive shares of the partnership’s tax items as reported on their respective income tax returns. Importantly, partners are subject to tax on their distributive shares of a partnership’s tax items (a tax reporting concept) regardless of whether the partnership makes distributions of cash to its partners (an economic concept). As such, it is necessary to distinguish between a partner’s distributive (or allocated) share of the partnership’s tax items and distributions of partnership cash.

To read the full practice note in Lexis Practice Advisor, follow this link.

Richard Lieberman is a senior counsel in the Chicago office of Dykema and a member of the firm’s Tax Practice Group. With more than 30 years of broad transactional and structuring experience, Mr. Lieberman concentrates his practice on the use of corporations, partnerships, and limited liability companies in domestic and cross-border acquisitions, restructurings, mergers, and financing transactions. He also advises Dykema’s clients on tax issues related to executive compensation arrangements, including designing and advising on the implementation of executive, equity, and deferred compensation programs.

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