Tax Receivable Agreement Liability: What You Need to Know
A Tax Receivable Agreement or TRA is a legal document that establishes how future tax benefits will be distributed after a company has gone through a change of ownership. This agreement is often put in place to compensate the original owners for any tax liabilities that may arise from selling their shares in the company. However, it is important to understand the potential liability that comes with a TRA.
TRAs are typically put in place when a company goes public or undergoes a merger or acquisition. The agreement outlines how any future tax benefits related to the company`s pre-acquisition or pre-IPO tax attributes will be distributed between the original owners and the new owners. These tax attributes may include net operating losses, research and development credits, and other tax-related items.
While TRAs can be advantageous for both parties, they also come with potential liability risks. The liability arises from the fact that the original owners are entitled to a portion of the future tax benefits associated with the pre-acquisition or pre-IPO tax attributes. This means that if the company experiences unexpected tax liabilities in the future, the original owners may be responsible for paying a portion of those liabilities.
For example, let`s say a company undergoes a merger and establishes a TRA with the original owners. The TRA states that the original owners are entitled to a portion of any future tax benefits related to the company`s pre-merger tax attributes. A few years after the merger, the company is audited by the IRS and it is discovered that the company owes back taxes. The original owners may be liable for a portion of those back taxes, even though they no longer own the company.
To protect themselves from potential liability, it is important for original owners to carefully review and negotiate the terms of a TRA before signing. The agreement should include clear language regarding liability and indemnification. Additionally, it may be wise for original owners to consult with a tax attorney to ensure they fully understand the potential risks associated with a TRA.
In conclusion, TRAs can be a useful tool for compensating original owners for the sale of their shares in a company. However, it is important for all parties involved to understand the potential liability that comes with a TRA. Careful review and negotiation of the agreement, as well as consultation with a tax attorney, can help mitigate any potential risks.