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Abstract

In May 2005 the Internal Revenue Service (IRS) and the Treasury Department issued proposed regulations and a revenue procedure that covered the federal income tax consequences of partnership equity transferred in connection with the performance of partnership services. A notable context in which the proposed regulations and revenue procedure may apply is the practice of law. For example, a law firm associate may become eligible for the coveted title of "partner" after several years of employment with his law firm. Depending on the law firm's structure, the associate-now-partner may act as a pure "service partner" whereby he will make no further contribution to the partnership other than his continued provision of services. In exchange, the new partner is entitled to an ownership share of the partnership's profits in addition to his regular salary. Thus, with the exception of a higher billing rate and an increased level of authority over the younger associates, the partner's duties remain largely the same as they were when the partner was an associate. Moreover, the time may come when the partner will leave his firm and either retire or seek other employment. As a result, his compensation will cease, and assuming that he has no desire to take clients with him, speaking in terms of tangibles, he will walk away with little more than what he started with-a law degree and a license to practice law.

As simple as the above scenario seems, tax practice in this area has been a topic of debate, confusion, and impending change. Commentators have expressed varying opinions on the subject, and the tax bar has extensively critiqued the recent proposed changes in this area of law. This Comment will focus on two narrow aspects of the scenario described above: (1) the entering of a service partner for a profits interest to a "service partnership," a partnership in which substantially all of its activities involve the provision of services; and (2) the later forfeiture by the partner of the profits interest. The purpose of this Comment is to describe the current law and methods of practice in this area. In addition, this Comment will highlight and analyze areas of importance that a practitioner should understand if the proposed methods become final. Finally, this Comment will conclude by noting a few areas that are in need of clarification by the IRS and the Treasury Department before finalization of the proposed scheme.

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