How Tax Receivable Agreements Work: Payments, Limits, and Accounting

A tax receivable agreement, or TRA, is a contract that requires a newly public corporation to pay its pre-IPO owners a share of the cash tax savings the company realizes from tax attributes created by the IPO restructuring. The share is almost always 85%, paid annually, and only when the company actually uses those attributes to reduce a real tax bill.¹ The remaining 15% stays with the corporation as its own benefit, which is the reason it agreed to the structure in the first place.

Where the Tax Savings Come From

TRAs almost always sit on top of an “Up-C” IPO. A pass-through entity such as an LLC or partnership doesn’t convert itself into a corporation. Instead, a new corporation (often called PubCo) is formed above the existing operating partnership. PubCo sells shares to the public, uses the proceeds to buy into the partnership, and the pre-IPO owners keep their partnership units with the right to exchange them later for PubCo stock.²

Each exchange is a taxable event, and each one creates fresh tax deductions for PubCo. The partnership has to file a Section 754 election with the IRS for this to work; without it, no basis adjustment occurs and the TRA has nothing to share.³ With the election in place, each exchange triggers a basis step-up under Section 743(b). PubCo’s share of the partnership’s assets gets a higher tax basis, which produces larger depreciation and amortization deductions and lower taxable income.

Two kinds of tax attributes dominate most TRAs. The first is that basis step-up itself. When it lands on intangibles like goodwill, the deductions amortize over 15 years under Section 197.⁴⁵⁶ Some agreements also cover imputed interest on the TRA payments themselves, but step-ups and NOLs do most of the work.

How a Payment Is Calculated Each Year

A TRA generates a payment only when PubCo actually saves cash on taxes. A deduction on paper is worth nothing until there is taxable income to apply it against.

Each year, PubCo runs two tax calculations. The first is its actual federal (and typically state) tax liability using every available deduction, including the TRA-covered attributes. The second is a hypothetical liability calculated as if those attributes didn’t exist. The difference is the realized cash tax savings for the year.¹

The TRA payment is a contractual percentage of that figure. In nearly every public agreement, the percentage is 85%.¹ A quick example: if PubCo would owe $10 million without the TRA attributes and owes $2 million with them, the cash savings are $8 million. At 85%, the former owners receive $6.8 million and PubCo keeps $1.2 million.

If PubCo has no taxable income in a given year, there are no realized savings and no payment is owed. The deductions aren’t lost. They wait, and the former owners wait with them.

When Payments Are Made and How Long They Last

Payments are typically annual, made within a few months after PubCo files its federal income tax return. Late payments usually accrue interest, and most agreements designate an independent accounting firm to settle disputes over the calculation.

A TRA stays alive as long as the covered attributes keep producing deductions. Payments tied to Section 197 intangibles run roughly 15 years.⁴ Payments tied to NOLs can run even longer because post-2017 NOLs carry forward indefinitely. The agreement terminates only once every covered attribute has been used up or has expired.

Early Termination and Change of Control

This is where a TRA can get expensive quickly. Most agreements convert the entire remaining obligation into one lump-sum payment on certain trigger events. The most common trigger is a change of control: a sale or merger of PubCo. A material breach of the TRA can also accelerate it.

The lump sum equals the present value of all estimated future payments, discounted at a rate set by the agreement. In SEC filings, that early-termination rate is often defined as the lesser of a fixed cap (commonly around 6.5%) or a floating benchmark such as SOFR plus 100 basis points.⁷

The number is calculated using “valuation assumptions” that are deliberately favorable to the former owners. The standard assumption set requires the company to project that it will earn enough taxable income to fully use every remaining attribute over its entire statutory life, and that current tax rates stay unchanged.⁷ The lump sum can easily exceed what the company would ever have paid in the ordinary course. For an acquirer evaluating a target, the acceleration payment is a real deal cost, sometimes running into the hundreds of millions.

What Can Shrink or Delay Payments

TRA payments are contingent by design. Several things can shrink them, stretch them out, or cut them off.

Not Enough Taxable Income

If PubCo isn’t profitable, or if other deductions push taxable income near zero, the TRA-covered attributes sit unused and no payment is triggered that year. The deductions carry forward, but former owners carry the real risk that the company never fully uses them. A high-growth company that goes public with ambitious projections can generate little TRA value for years if those projections slip.

Section 382 Caps on NOL Use

An IPO itself can trigger a cap on how fast pre-change NOLs can be used. Section 382 imposes an annual limit when one or more 5-percent shareholders increase their collective ownership by more than 50 percentage points over a rolling three-year window.⁸ New public shareholders are treated as a single 5-percent shareholder for this test, so an IPO can easily cross the threshold.

The annual cap equals the company’s fair market value immediately before the ownership change multiplied by the IRS-published federal long-term tax-exempt rate.⁸ If the cap is lower than the NOLs the company would otherwise use in a year, the excess waits. Payments stretch out and the present value of the obligation falls. The basis step-up from unit exchanges generally isn’t subject to the same cap because it arises from a new transaction rather than a pre-change loss, but any TRA covering NOLs should be read with Section 382 in mind.

Tax Law Changes

Because every payment is a percentage of actual tax savings, the corporate rate is a direct multiplier. At the current 21% rate, a $100 million basis step-up produces $21 million in total tax savings. At 28%, the same step-up produces $28 million, a 33% jump in TRA payments. A rate cut works in reverse. Tightening the NOL rules (shorter carryforward, lower utilization cap) can mean some covered deductions are never used. State tax rate changes also move the number, since most agreements cover state and local income tax savings; state corporate rates currently run from roughly 2% to nearly 12%.

IRS Audits

If the IRS or a state tax authority challenges the basis step-up or the amount of available NOLs and wins a disallowance, the tax savings shrink retroactively. Most TRAs handle this with “true-up” provisions that adjust future payments. Some include explicit clawback language. How overpayments actually come back (escrow, indemnification, offset against future payments) depends on how the specific agreement is drafted.

How a TRA Shows Up on the Financial Statements

Public companies account for TRAs primarily under ASC Topic 740 (Income Taxes), and the obligation can swing reported earnings materially from quarter to quarter.⁹

When a pre-IPO owner exchanges units for stock, PubCo books a deferred tax asset for the future benefit of the step-up and a TRA liability for the 85% owed back to the former owner. Because both come out of an equity transaction, the TRA liability is initially recorded as a reduction of additional paid-in capital, not as an expense.¹

After that, the liability gets remeasured every reporting period, and the adjustments run through the income statement. A downward revision of future taxable income shrinks the liability and produces a reported gain. A corporate tax rate increase enlarges the liability and produces a loss. Some companies park these amounts in other income and expense; others fold them into the income tax provision. The footnotes are the only way to tell which. A single remeasurement can distort operating results in either direction.

There’s also an asymmetry worth knowing about. The deferred tax asset must be tested for realizability, and management has to record a valuation allowance against any portion the company isn’t more likely than not to use. The TRA liability is a contract and isn’t subject to that test. So the DTA can be written down while the liability sits at a higher level, producing a mismatch that catches investors off guard when they read the balance sheet.

Public companies must disclose the key TRA terms in the footnotes: the share of tax savings payable, the projected payment schedule, the main assumptions behind the liability (discount rate and future taxable income), and the payments made in the period. For any investor trying to forecast cash obligations or an acquirer trying to price an acceleration, those footnotes and the agreement itself (filed with the SEC) are the documents to read.

1
DART – Deloitte Accounting Research Tool. Statement of Cash Flows – Tax Receivable Agreements
2
Deloitte. Up-C Structure For Pass-Through Entities
3
Office of the Law Revision Counsel. 26 USC 754 – Manner of Electing Optional Adjustment to Basis of Partnership Property
4
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
5
Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction
6
Internal Revenue Service. Instructions for Form 172 – Net Operating Losses
7
U.S. Securities and Exchange Commission. Cardinal Inc – Tax Receivable Agreement
8
Office of the Law Revision Counsel. 26 USC 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change
9
KPMG. Accounting for Income Taxes