Final regulations - Tax treatment of noncompensatory options, convertible instruments issued by partnerships 

February 4:   The Treasury Department and IRS today released for publication in the Federal Register final regulations (T.D. 9612) concerning the tax consequences of issuing, transferring, and exercising or converting certain call options, warrants, convertible debt, and convertible equity not issued in connection with the performance of services (noncompensatory options).

The final regulations [PDF 168 KB]:


  • Generally provide that the exercise of a noncompensatory option does not cause the recognition of immediate income or loss by either the issuing partnership or the option holder
  • Modify the regulations under section 704(b) regarding the maintenance of the partners’ capital accounts and the determination of the partners’ distributive shares of partnership items
  • Include a characterization rule providing that the holder of a noncompensatory option is treated as a partner under certain circumstances

Also today, Treasury and the IRS released related proposed regulations (REG-106918-08) for publication in the Federal Register. The proposed regulations [PDF 85 KB] consider the character of gain or loss recognized upon a lapse, repurchase, sale or exchange and would:


  • Expand the characterization rule measurement events to include certain transfers of interests in the issuing partnership and the other look-through entities
  • Provide additional guidance in determining the character of the grantor’s gain or loss as a result of a closing transaction with respect to (or a lapse of) an option on a partnership interest by treating partnership interests as securities for purposes of section 1234(b)

The preamble to today’s final regulations explains that a number of comments were received in response to regulations proposed in 2003 and that the 2003 proposed regulations are adopted with revisions in response to comments.


Read a preliminary report [PDF 80 KB] describing today’s final and proposed regulations, prepared by KPMG LLP: Final regulations - Tax treatment of noncompensatory options, convertible instruments issued by partnerships



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