Use of Transaction Based Compensation Exception with an LLC

[EGB]

I would appreciate any thoughts on the ability to use the transaction based compensation exemption ("TBCE") under the Section 409A regulations in the context of a limited liability company (or a partnership for that matter). The TBCE is written in terms of "stock" but I am wondering if, per Notice 2005-1, Q&A-7, we can in good faith read the exemption to apply in the context of a membership interest (or partnership interest) instead of stock.

[Guest Subsequent Deferral]

I think there are two different views on this: (1) that stock within 409A only refers to options and SARs, and that (2) it applies to any equity vehicle, including capital interests, profit interests/membership units, etc of an LLC. Obvously (1) if the more conservative view. But, (2) could be taken and I have seen it be taken before in the context of a transaction, but it is done so at the attorney's peril.

[Guest carltberry]

This was in the commentary to the proposed regulations. I don't see anything similar in the final regulation's commentary; but the IRS did say to rely on it until new guidance is provided (which hasn't happened to my knowledge), for what it's worth it. The spirit of it seems to suggest to "do things by analogy" to non-corporations.

"Commentators asked whether the provisions relating to the change in ownership or effective control of a corporation will be extended to non-corporate entities. Specifically, some commentators asked whether change in control provisions could be applied in the case of a partnership or other pass-through entity. Neither the statute nor the legislative history refers to a permissible distribution upon a change in ownership or effective control of any type of entity other than a corporation.

However, the Treasury Department and the IRS plan to issue regulations under section 409A(a)(3) that will allow an acceleration of payments upon a change in the ownership of a partnership or in the ownership of a substantial portion of the assets of the partnership. Until further guidance is issued, the section 409A rules regarding permissible distributions upon a change in the ownership of a corporation (as described in proposed §1.409A-3(g)(5)(iv)) or a change in the ownership of a substantial portion of the assets of a corporation (as described in proposed §1.409A-3(g)(5)(vi)) may be applied by analogy to changes in the ownership of a partnership and changes in the ownership of a substantial portion of the assets of a partnership. For purposes of this paragraph, any references in proposed §1.409A-3(g)(5) to corporations, shareholders, and stock shall be treated as referring also to partnerships, partners, and partnership interests, respectively, and any reference to "majority shareholder" as applied by analogy to the owner of a partnership shall be treated as referring to a partner that (a) owns more than 50 percent of the capital and profits interests of such partnership, and (b) alone or together with others is vested with the continuing exclusive authority to make the management decisions necessary to conduct the business for which the partnership was formed. The Treasury Department and the IRS request comments with respect to the application of a change in control provision to partnerships and other non-corporate entities, as well as suggestions with respect to the formulation of which types of events should qualify and would be analogous to the corporate events described in the regulations."

[EGB]

This was in the commentary to the proposed regulations. I don't see anything similar in the final regulation's commentary; but the IRS did say to rely on it until new guidance is provided (which hasn't happened to my knowledge), for what it's worth it. The spirit of it seems to suggest to "do things by analogy" to non-corporations.

"Commentators asked whether the provisions relating to the change in ownership or effective control of a corporation will be extended to non-corporate entities. Specifically, some commentators asked whether change in control provisions could be applied in the case of a partnership or other pass-through entity. Neither the statute nor the legislative history refers to a permissible distribution upon a change in ownership or effective control of any type of entity other than a corporation.

However, the Treasury Department and the IRS plan to issue regulations under section 409A(a)(3) that will allow an acceleration of payments upon a change in the ownership of a partnership or in the ownership of a substantial portion of the assets of the partnership. Until further guidance is issued, the section 409A rules regarding permissible distributions upon a change in the ownership of a corporation (as described in proposed §1.409A-3(g)(5)(iv)) or a change in the ownership of a substantial portion of the assets of a corporation (as described in proposed §1.409A-3(g)(5)(vi)) may be applied by analogy to changes in the ownership of a partnership and changes in the ownership of a substantial portion of the assets of a partnership. For purposes of this paragraph, any references in proposed §1.409A-3(g)(5) to corporations, shareholders, and stock shall be treated as referring also to partnerships, partners, and partnership interests, respectively, and any reference to "majority shareholder" as applied by analogy to the owner of a partnership shall be treated as referring to a partner that (a) owns more than 50 percent of the capital and profits interests of such partnership, and (b) alone or together with others is vested with the continuing exclusive authority to make the management decisions necessary to conduct the business for which the partnership was formed. The Treasury Department and the IRS request comments with respect to the application of a change in control provision to partnerships and other non-corporate entities, as well as suggestions with respect to the formulation of which types of events should qualify and would be analogous to the corporate events described in the regulations."

[EGB]

Thanks for your post, Carltberry. I think the real issue is whether we are able to take what you quoted and use it in other contexts. What you quoted was in the context of allowing an accleration in the event of a change in ownership or effective control of a corporation. Can this general idea of "doing things by analogy" to non-corporations be used in the context of utilization of the transaction based compensation exemption? I have advised against it since it is unclear.