A profits interest is an equity interest in an LLC or partnership entitling the holder to a share of future profits and appreciation, but not to the value existing at grant. It is the standard way to give operating partners equity without triggering immediate tax.

The threshold amount. At grant, the interest must have no liquidation value — the existing members would receive the entire enterprise value if the company were sold that day. This is implemented by a distribution threshold or hurdle recorded in the grant and in the operating agreement.

Tax treatment. Properly structured, the grant is not a taxable event and subsequent income is allocated as partnership income. Structuring failures — notably an incorrect threshold — convert it into a taxable capital interest.

Election considerations. A protective election within the statutory window after grant is customary where there is any risk the interest is treated as substantially non-vested.

Employment consequences. A holder of a partnership interest is generally not an employee for tax purposes, which affects withholding, benefits and the issuance of tax reporting forms. This surprises companies converting employees into equity holders.

Vesting and forfeiture. Time and performance vesting, treatment on termination for cause and without, and repurchase rights should be specified in the award agreement rather than left to the operating agreement’s defaults.