Proposed Regulations on Noncompensatory Options: A Light at the End of the Tunnel

It has become increasingly common for partnerships to issue options. There is a dearth of authority on the federal tax treatment of options to acquire interests in partnerships. In this context, there are two main categories of options, services options and noncompensatory options. Services options, unsurprisingly, are options to acquire partnership interests where the option is received in exchange for services. Noncompensatory options cover the rest of the waterfront. The simplest version of the latter would be partnership analog to normal options found outside the partnership context: the option holder pays the partnership an option premium to acquire an option to purchase a partnership interest sometime in the future for a fixed price. A previous article by this author discussed services options (Walter D. Schwidetzky, Options to Acquire Partnership Interests, Can the Tax Law Keep Pace? 20(2) Journal of Investment Taxation 99 (Winter 2003)), and this article serves as a companion piece, focusing primarily on the recently issued proposed regulations on the tax treatment of noncompensatory options. The article will describe and analyze the proposed regulations and offer alternatives