Profits Interest
Candlefocus EditorUnder the profits interest model, the partnership awards employees with a contract that entitles them to a portion of the future growth in value of the partnership. Depending on the agreement and the current value of the business, the partnership may fix the amount of profits interest awarded, or they may leave the amount to be determined later, after the value is known.
In return for being given a profits interest, the employee agrees to continue working with the partnership and to direct their efforts toward increasing the value of the business. This incentive is preferable for many business partners, particularly when the business does not have equity to grant employees or if the employees wish to remain an active part of the partnership.
Notably, the profits interest model does trigger some changes in the way the partnership handles taxes and some benefit programs. For instance, any profits interest held by the employee is subject to self-employment tax, and those payments must be reported and taxes paid appropriately. Furthermore, depending on the terms of the profits interest agreement, certain benefits, such as 401(k) and medical insurance, may become available through the profits interest held by the employee.
Overall, profits interest is an increasingly popular way for partnerships to motivate and reward key employees, without granting actual equity. The profits interest model provides an incentive for the employee to stay with the partnership and work toward increasing the value of the business, in exchange for a share of the profits if the business grows. Moreover, profits interest also triggers some changes in tax filing procedures and certain benefit programs.