In a recent case, ES NPA Holding, LLC, et al. v. Commissioner, T.C. Memo. 2023-55, the U.S. Tax Court analyzed profits interests held indirectly through a multi-tier structure. In its analysis, the Court confirmed that a service provider’s profits interests in an operating company (a “Company”) which are held indirectly through a holding company (an “Aggregator”) were valid profits interests. The U.S. Tax Court has now validated this multi-tier structure, which has become a standard practice in the market to address issues such as allowing recipients of profits interests to be employees of the Company (even here, the IRS did not challenge the profits interests based on their indirect ownership).

In this case, a Company granted profits interests to an Aggregator in exchange for services provided by the taxpayer to the Company. The taxpayer in turn received profits interests in the Aggregator as a result of providing those services to the Company. The Court included in its findings that “[i]t is of no material consequence that [the taxpayer]’s interest in [the Company] is held indirectly through [the Aggregator], which is a mere conduit since the liquidation rights in the [profits interests] in both [the Aggregator] and [the Company] are identical.”

This case has settled that multi-tier structures, which have been used in practice for some time now, can be used to indirectly hold profits interests in operating companies.

This article is not meant to be an exhaustive description of all of the tax requirements for valid profits interests. If you would like to further discuss profits interests or other tax issues, please contact Jeff Groshek or Charles McGonigal.

This summary does not include or address every provision of the applicable tax laws discussed above. Any information contained in this communication is not intended as a thorough, in-depth analysis of specific issues. It is also not sufficient to avoid tax-related penalties. This has been prepared for informational purposes and general guidance only, and does not constitute legal advice. You should not act upon the information contained in this publication without obtaining specific legal advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and Hinckley Allen, its members, employees, and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.