Partnership Securities

Abstract

The convergence of the individual and corporate tax rates and the repeal of the General Utilities doctrine have increased the cost of doing business in corporate form and the attractiveness of operating a business as a partnership. That attractiveness has been reinforced by the growing availability of limited liability companies. The proliferation of partnerships has increased the interest in partnerships' issuing securities similar to those issued by corporations-capital interests, options and profits interests that are the partnership equivalent of "stock appreciation rights." However, there has been little discussion of the tax consequences of partnerships issuing securities apart from the long-standing debate as to whether the recipient of a partnership profits interest for services should be subject to tax. That debate has been resolved, as a practical matter, by Revenue Procedure 93-27, in which the Internal Revenue Service ruled that, subject to certain exceptions, the receipt of profits interests for services is not taxable. This resolution makes timely an analysis of the consequences to the partnership and other partners of a partnership's issuance of partnership securities.
This article, through a series of examples, considers the possible consequences under current law of the receipt by a partner of a capital interest, an option and a profits interest for either cash or services. These consequences differ depending on whether a partnership is viewed as an entity or aggregate. The article recommends the adoption of an entity approach that permits the consequences of a partnership's issuance of securities to resemble those of corporate issuances. This recommendation requires reconsidering the accepted view of the tax consequences of a partnership's issuing a capital interest for services.