The IRS has finalized its 2003 proposed regulations on noncompensatory partnership options (T.D. 9612) and issued new proposed regulations (REG-106918-08) on other aspects of the rules.
The final regulations deal with options that are not issued in connection with the performance of services and apply to these noncompensatory options issued on or after Feb. 5, 2013. The most significant rules in the final regulations will generally:
- adopt the open transaction treatment approach of the 2003 proposed regulations so that a partnership does not recognize gain or loss when an option is issued,
- provide that the exercise of a noncompensatory option does not cause the recognition of immediate income or loss by either the issuing partnership or the option holder,
- modify the regulations under Section 704(b) regarding the maintenance of the partners' capital accounts and the determination of the partners' distributive shares of partnership items, and
- include a characterization rule providing that the holder of a noncompensatory option is treated as a partner under certain circumstances.
The proposed regulations consider the character of gain or loss recognized upon a lapse, repurchase, sale or exchange. They generally would:
- expand the characterization rule measurement events (relating to treating an option holder as a partner under certain circumstances) to include certain transfers of interests in the issuing partnership and other look-through entities, and
- provide guidance in determining the character of the grantor's gain or loss as the result of an option in a partnership interest closing in a transaction (or lapsing) by treating partnership interests as securities for purposes of Section 1234(b).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.