Conversion to Partnership Tax Status: Tax Risks Associated with Management Equity Incentives

Summary

Business owners often desire to attract, retain, motivate, and reward a key group of employees by aligning the financial interests of such individuals with the financial interests of the owners. There are a number of ways to accomplish this objective using synthetic equity, such as phantom stock, or a bonus plan. In the context of a business taxed as a partnership for U.S. federal income tax purposes, a stronger incentive involves the grant of a profits interest, which, under certain circumstances, would not incur an immediate tax consequence and can result in long-term capital gain treatment upon a subsequent sale of the company or other similar capital event.