Are "Profits Interests" Synthetic Equity

[ERISA-Bubs]

We have an S-Corp that owns a related entity. I know the synthetic equity of a related entity is included in the S-Corp's 409(p) testing.

Several participants have profits interests in the related entity. This gives them a right to share in the profits of the related entity, but it's not directly related to the value of the stock of the related entity.

Should we include these profits interests in our 409(p) test?

If so, how do we determine the number of shares the profits interests are equal to for purposes of the 409(p) test?

[ESOP Guy]

I think we need more information to come up with an answer.

Are these "profit interests" paid in cash every year that is taxable or is it some kind of deferred comp?

If paid every year in a way that is taxable why isn't this just a type of cash bonus?

[Griswold]

Based on the definition in 409(p)(6)©, my best guess is, no, don't use them.

"The term "synthetic equity" means any stock option, warrant, restricted stock, deferred issuance stock right, or similar interest or right that gives the holder the right to acquire or receive stock of the S Corporation in the future. Except to the extent provided in regulations, synthetic equity also includes a stock appreciation right, phantom stock unit, or similar right to a future cash payment based on the value of such stock or appreciation in value."

Profits Interest are something you find in partnerships--instead of a capital interest, you get a profits interest. So, instead of liquidation rights, you get a potential distribution if and when the partnership gets income. So, conceptually, I don't think it makes sense to include them.