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Tax News
No Peace for Noncompensatory Partnership Options
January 11, 2011
Administrative Actions
I opened TNT today and what do I see - a piece by Monte Jackel titled Reprise of the Noncompensatory Option Regs. 2011 TNT 7-7.  So in essence, in this article, Mr. Jackel disagrees with major components of the noncompensatory partnership options regulations. Honestly, I did not read the whole article, although I am sure, as always Monte’s analysis is comprehensive and thoughtful. To me, the import of this was more in the vain, “Oh, here we go again.” To those that are not aware, the noncompensatory proposed regulations have been proposed since 2003.  The fact that a regulation has been proposed for many years without being finalized is a troubling fact in itself. Nonetheless, many practitioners (including me) thought that the proposed regulations offered a respectable framework addressing a difficult issue. Not only that, but at least they offered some uniform guidance regarding the exercise of noncompensatory partnership options. That alone was worth something, at least to me.

Noncompensatory partnership options are not that prevalent in the investment fund context.  When could the issue come up? For example, the investment fund could issue options instead of partnership interest to some of its employees or managers. Why might an employee or manger prefer options – for one, while being an option holder, the employee or manager do not receive allocations of fund related income. The issue could come up at the portfolio company level as well. Convertible debt is common enough, but sometimes the fund may invest in straight debt coupled with a noncompensatory option, i.e. an investment unit. So when I was faced with these scenarios, I could at least point out to the proposed regulations and reason that while these are not binding, at least they represent the current position of the Service. While this may not offer clients rock solid assurance, it is at least some comfort. So Mr. Jackel now says, well, these regulations are wrong. What does all of this mean?  Well, at least to me, it means that when advising funds regarding this tax issue, I have to point out that there is hardly any certainty in the matter. Hopefully this topic will be settled once and for all. No doubt, volumes have been written about it and it seems it is time for Treasury to take final action.  So meanwhile, what does Treasury do - it re-examines certain aspects of the proposed regulations and plans to re-issue them in 2011. See 2010 TNT 202-3. I personally do not find any of this too reassuring and have difficulty understanding how an issue of this caliber can be left without a definitive guidance for so many years.
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Tags: noncompensatory partnership options, REG-103580-02