Disguised payments for services; guaranteed payments

Disguised payments for services; guaranteed payments

The Treasury Department and IRS today released for publication in the Federal Register proposed regulations (REG-115452-14) for partnerships and their partners regarding when an arrangement will be treated as a disguised payment for services under section 707(a)(2)(A).


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The proposed regulations [PDF 270 KB] also include conforming changes to the regulations governing guaranteed payments under section 707(c).

Today’s release further provides notice of proposed modifications to Rev. Proc. 93-27 (guidance on the treatment of the receipt of a profits interest for services provided to or for the benefit of the partnership) as clarified by Rev. Proc. 2001-43 relating to the issuance of interests in partnership profits to service providers.

The proposed regulations may have a significant impact on certain private equity arrangements, such as management fee waivers and cashless conversions.

Identifying “disguised payment for services”

Under the proposed regulations, an arrangement is treated as a disguised payment for services if:

  • A person (service provider), either in a partner capacity or in anticipation of being a partner, performs services (directly or through its delegate) to or for the benefit of the partnership;
  • There is a related direct or indirect allocation and distribution to the service provider; and
  • The performance of the services and the allocation and distribution when viewed together, are properly characterized as a transaction occurring between the partnership and a person acting other than in that person’s capacity as a partner.

The proposed regulations characterize the nature of an arrangement at the time the parties enter into or modify the arrangement. The proposed regulations apply to both one-time transactions and continuing arrangements. A disguised payment for services will be treated as a payment for services for all purposes of the Code. The proposed regulations do not specifically address the timing for including the income or deduction related to the disguised payment.


The proposed regulations provide six non-exclusive factors to be used in determining whether an arrangement constitutes a disguised payment for services. The most important factor is whether the arrangement has significant entrepreneurial risk. Under the proposed regulations, the following facts and circumstance create a presumption that an arrangement lacks significant entrepreneurial risk:

  • Capped allocations of partnership income if the cap is reasonably expected to apply in most years
  • An allocation for one or more years under which the service provider’s share of income is reasonably certain
  • An allocation of gross income
  • An allocation (under a formula or otherwise) that is predominately fixed in amount, is reasonably determinable, or is designed to assure that sufficient net profits are highly likely to be available
  • An arrangement in which a service provider waives its rights to receive payment for the future performance of services in a manner that is non-binding or fails to timely notify the partnership and its partners of the waiver and its terms
The other five factors in addition to significant entrepreneurial risk are:
  • The service provider holds, or is expected to hold, a transitory partnership interest or a partnership interest for only a short duration
  • The service provider receives an allocation and distribution in a time frame comparable to the time frame that a non-partner service provider would typically receive payment
  • The service provider became a partner primarily to obtain tax benefits which would not have been available if the services were rendered to the partnership in a third-party capacity
  • The value of the service provider’s interest in general and continuing partnership profits is small in relation to the allocation and distribution
  • The arrangement provides for different allocations or distributions with respect to different services received, when the services are provided either by a single person or by persons that are related under sections 707(b) or 267(b), and the terms of the differing allocations or distributions are subject to levels of entrepreneurial risk that vary significantly (this being the factor added by these proposed regulations)


The proposed regulations provide a number of examples, including examples of such common arrangements as management fee waivers and cashless conversions. The examples highlight that the most important factor in determining whether an arrangement is a disguised payment for services is the presence or absence of significant entrepreneurial risk.

Rev. Proc. 93-27 safe harbor

The preamble notes that the IRS and Treasury have determined that the safe harbor of Rev. Proc. 93-27 does not apply to transactions in which one party provides services and another party receives a seemingly associated allocation and distribution of income or gain—including a situation when a management company that provides services waives its fee and a party related to the management company receives an interest in future profits that approximates the amount of the waiver fee.

The preamble also notes that the IRS plans to issue a new exception to the safe harbor of Rev. Proc. 93-27. The additional exception will apply to a profits interest issued in conjunction with a partner forgoing payment of an amount that is substantially fixed (including a substantially fixed amount determined by formula, such as a fee based on a percentage of partner capital commitments) for the performance of services, including a guaranteed payment under section 707(c) or a payment in a non-partner capacity under section 707(a).

Proposed effective date

The proposed regulations are effective on the date the final regulations are published in the Federal Register, and would apply to any arrangement entered into or modified on or after the date of publication of the final regulations. The proposed regulations will apply to an arrangement entered into before the publication of final regulations if a service provider waivers all or a portion of its fee under the arrangement after the publication of final regulations.

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