How Does the Termination of Team Members Affect Incentive Compensation by LLCs Taxed as Partnerships?

Welcome to yet another enthralling edition of our incentive compensation series. Kudos on your perseverance thus far! In this post, we’ll delve into a question that often arises in the realm of Limited Liability Companies (LLCs) taxed as partnerships: What transpires when it comes to incentive compensation plans upon the termination of a team member? We shall unravel the various implications on profit interests, capital interests, options on capital interests, phantom equity, and additional cash incentives. The ramifications hinge on whether they are vested or unvested and the reason for termination. Brace yourself for an engaging and insightful journey!

For simplicity, we will divide termination into two categories: termination for cause and termination other than for cause. We will focus on four types of incentives: grants of capital interests, grants of options on capital interests, profit interests, and cash incentives such as phantom equity or bonuses. It's important to note that all unvested incentives will usually be forfeited in for termination for cause and for termination other than for cause.

Termination for Cause

When a team member is terminated for cause, the typical outcomes for vested incentives are as follows:

• Grants of capital interests are forfeited at cost, or simply forfeited if they were granted for no consideration.
• Unexercised options on capital interests are forfeited for no consideration.
• Profit interests are forfeited for no consideration.
• Cash incentives are terminated without payment.

Termination Other Than for Cause

When a team member is terminated other than for cause, the typical outcomes for vested incentives are as follows:

• The team member may be allowed to keep any granted capital interests or profit interests, or they may be redeemed by the LLC at fair market value.
• The team member's unexercised options on capital interests are either terminated, or the team member is given a limited period, such as one to three months, to exercise the Cash incentives are either terminated without payment or paid at the value of such incentives as of the date of termination.

In summary, when a member is terminated, the ramifications for incentive compensation plans depend on the type of incentive and the reason for termination. As always, it's important to consult with professionals to review the applicable provisions in the LLC operating agreement or incentive compensation agreement.

Conclusion

We hope this article has been informative and useful for your business. If you have any questions or comments, please contact us at info@wilkinsonlawllc.com. We plan to answer general questions in an upcoming FAQ series. If you need legal advice specific to your situation, please ask to schedule a consultation with an attorney to discuss your company’s goals.

Prepare yourself for the upcoming installment in our series tomorrow, where we will delve into Section 83(b) and its ramifications on incentive compensation for partnership-taxed LLCs.

This article is for informational purposes only and should not be relied upon as tax advice. Please consult your tax professional for advice tailored to your specific situation. The author and publisher assume no responsibility for any errors or omissions or for any actions taken based on the information presented.