Tax Law Alert - IRS Proposes Regulations on Disguised Payments For Services

07.23.15

The Internal Revenue Service issued proposed regulations today on “Disguised Payments for Services.” Published in the Federal Register as REG-115452-14, these regulations are designed to implement changes to legislation made by Congress back in 1984.

The proposed regulations explain the rules, and provide some examples, for situations in which distributions from a partnership interest will be treated as disguised compensation. In that case, the partnership distribution will be treated as ordinary, compensatory income, which is subject to self-employment tax if it is payable to an individual and deductible by the entity.

Some of the definitions or characterizations concerning guaranteed payments by partnerships will also be changed under the proposed regulations. Because of this, a 1981 Revenue Ruling will be modified and a 1966 and a 1969 Ruling will be revoked. So the IRS is changing some long established positions in these new proposed regulations. The preamble to the proposed regulations indicates that corresponding changes to the existing Revenue Procedures concerning and limiting the tax free issuance of a profits interest in a partnership will also be made.

In situations where there are fee waivers in exchange for a partnership interest, or partnership interests issued as profits interests that are comparable to those issued to other investors, the issuance of the profits interests may be a currently taxable event. The IRS acceptance of the tax free treatment of the issuance of a profits interest is based to a large extent on the fact that the valuation of most partnership profits interest is considered speculative. If the value can be reasonably ascertained by reference to other factors (such as the waiver of a fee or comparable investments), the profits interest will be capable of being valued and may be currently taxed.

With little detail provided, the preamble states that there will be changes to the Revenue Procedures on profits interests.  However, it is unlikely that they will change the ability to issue a profits interest tax free if the issuance is not in conjunction with some other factor that indicates the negotiated value of the interests.

Considered on the “fast track,” the proposed regulations are expected to be finalized shortly after year-end. In the meantime, the IRS stated that the regulations reflect Congressional guidance from legislative committee reports, and so they also reflect the new IRS audit position.

To read more about the proposed regulations, CLICK HERE for a short article on the subject.

If you are interested in reading the entire proposed regulations in the Federal Register, please CLICK HERE.

If you have questions or need further information about “Disguised Payments for Services” and the proposed new IRS regulations, contact Mark D. Anderson at (312) 755-3163 or the Aronberg Goldgehn attorney with whom you work.

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