A tax receivable agreement is a contract between a newly public corporation and its former owners that divides the cash value of future tax savings created when a partnership or LLC converts to a public corporate structure. In almost every case, the former owners receive 85% of those savings and the corporation keeps 15%, with payments stretching across 15 years or longer. These agreements appear almost exclusively in a specific IPO format known as the “Up-C,” and the obligations they create can run into the hundreds of millions of dollars. For anyone evaluating a company with one on its books, the TRA affects cash available for dividends, buybacks, and reinvestment, and it can swing dramatically in value if the company is acquired.
Where the Tax Savings Come From
TRAs exist because partnerships and corporations are taxed differently. A partnership’s profits flow through to its owners, and the entity’s “tax basis” in its assets often sits well below what the ownership interests are actually worth after years of growth. When a corporation takes over those interests, the tax code allows an adjustment that closes the gap, and the resulting deductions are what the TRA splits.
In an Up-C IPO, the original owners don’t sell their partnership interests outright. A new holding company (often called “PubCo”) is formed on top of the existing partnership. PubCo issues Class A shares to public investors with full voting and economic rights, and Class B shares to the original owners that carry voting rights but no economic stake in PubCo itself. The original owners keep their partnership units alongside those Class B shares and can exchange their units for Class A shares one-for-one over time.
Each exchange lets the partnership elect under Section 754 of the Internal Revenue Code to step up the tax basis of its underlying assets to reflect the fair market value of the exchanged interest.1Office of the Law Revision Counsel. 26 USC 754 The adjustment itself is computed under Section 743(b), which raises asset basis by the difference between what the transferee paid and their share of the partnership’s existing basis.2Office of the Law Revision Counsel. 26 US Code 743 – Special Rules Where Section 754 Election or Substantial Built-In Loss The higher basis produces larger depreciation and amortization deductions in future years. For intangibles like goodwill and customer relationships, Section 197 requires the step-up to be amortized over 15 years.3Office of the Law Revision Counsel. 26 US Code 197 – Amortization of Goodwill and Certain Other Intangibles Those deductions reduce the corporation’s taxable income each year, and the TRA governs who gets the resulting cash.
Why 85 Percent Goes to the Former Owners
The 85/15 split has become so standard it appears in nearly every Up-C IPO prospectus.4Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements The reasoning is that the basis step-up only exists because of the conversion structure the former owners agreed to. Without a TRA, the corporation would capture 100% of the savings, effectively transferring value from the original owners to new public shareholders. Returning 85% to the people who built the business, while leaving 15% with the corporation, has become the market convention. The retained slice also gives the public company a built-in incentive to manage its tax position efficiently.
How the Annual Payment Is Calculated
TRA payments are not fixed installments. They move each year with the corporation’s actual tax situation.
The calculation starts with a hypothetical: what the corporation would owe if it had none of the step-up deductions from the Up-C exchanges. That hypothetical liability is then compared to the actual tax liability, which reflects the benefit of the extra amortization and depreciation. The gap between the two is the cash tax savings for the year. The corporation applies the 85% contractual percentage to that amount to determine the payment.
The federal corporate income tax rate of 21% is a core input, but state and local income taxes also factor in.5Worldwide Tax Summaries. United States – Corporate – Taxes on Corporate Income State corporate rates run roughly from 2% to nearly 12%, so the blended rate used in TRA math can be meaningfully higher than 21%. The TRA specifies how the aggregate rate is set, and that methodology is disclosed in public filings. Payment timing is generally tied to when the corporation files its annual return. Deferred or late payments typically accrue interest at a benchmark rate such as SOFR plus 100 basis points.6U.S. Securities and Exchange Commission. Tax Receivable Agreement – Cardinal Infrastructure Group Inc.
Loss Years
If the corporation posts a net operating loss, it has no taxable income for the step-up deductions to shelter. No tax savings are realized, and no TRA payment is owed for that period. The unused deductions carry forward to future profitable years. The former owners bear the risk that the company might not generate enough income to use the attributes within the contract period.
Tax Rate Changes
A legislative change to the corporate rate flows straight into future TRA payments. A rate increase makes each dollar of deduction more valuable and raises the payment stream; a rate cut shrinks it. This gives former owners a financial interest in higher corporate tax rates, which can diverge from what public shareholders prefer.
What a TRA Looks Like on the Financial Statements
When the initial exchanges occur, the corporation recognizes a deferred tax asset for the future tax benefit it expects from the step-up, and at the same time records a TRA liability for the 85% share it expects to pay out. Both entries are initially booked through equity because they arise from an equity reorganization rather than operations.4Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements
The deferred tax asset requires judgment. If the corporation cannot show it is “more likely than not” to generate enough future taxable income to use the benefits, it must record a valuation allowance that reduces the asset. A full valuation allowance drops the deferred tax asset to zero, and the TRA liability is recorded at zero as well, since there are no expected savings to share.4Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements
After initial recognition, any change in the expected future tax savings (from revised income projections, enacted tax rate changes, or new exchanges by additional former owners) requires remeasurement of both the deferred tax asset and the TRA liability. Those adjustments run through the income statement rather than equity and can produce large non-cash gains or losses that have nothing to do with the company’s core operations.4Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements GAAP net income can swing on TRA remeasurement in ways that mislead if you don’t know to look.
What Happens If the Company Is Acquired
In normal operations, TRA payments trickle out over 15 years or more, and the obligation stays contingent on profitability. A sale changes that completely. Most TRAs contain acceleration clauses triggered by a change of control such as a merger or acquisition. When triggered, the corporation must immediately pay the former owners a lump sum representing the present value of all remaining expected payments.7U.S. Securities and Exchange Commission. Tax Receivable Agreement – Birkenstock Holding plc
The assumptions built into that lump sum are what make it dangerous. The payment is calculated as if the corporation will be profitable enough to use every remaining tax attribute over the full contract term, whether or not that is realistic. The discount rate is typically modest (often SOFR plus 100 basis points), so the present-value haircut is small. The calculation also ignores limitations on using tax attributes that may follow the deal itself, such as the annual limits Section 382 imposes after ownership changes.7U.S. Securities and Exchange Commission. Tax Receivable Agreement – Birkenstock Holding plc An acceleration payment can far exceed what the former owners would have actually received under normal operations, and acquirers must price it into any deal.
Some TRAs also let the corporation itself trigger an early termination, buying out the remaining obligation on similar assumptions. That can make sense if the company expects its future tax savings to be large enough that paying the present value now beats making larger annual payments later.
Risks for Public Shareholders
TRAs have drawn sustained criticism from corporate governance advocates, and the concerns matter when evaluating a company with one on its balance sheet.
The core issue is incentive misalignment. When a private equity sponsor or founder holds both a controlling stake and TRA rights, they may favor a sale even when staying independent would serve minority shareholders better. A sale triggers acceleration, converting the TRA into a large immediate payout to the controlling shareholder in which minority shareholders do not participate. A Delaware Chancery Court addressed this conflict directly, finding it reasonably conceivable that a private equity sponsor’s expected early termination payment created a material conflict of interest that may have driven a sale process that was not in minority shareholders’ best interest.
Real examples show the range. In 2022, GoDaddy’s board faced a shareholder lawsuit for approving a plan to pay roughly $850 million to the company’s founder and private equity backers under a TRA, far above the $175 million carrying value on the audited financial statements. On the other end, the beneficiaries of PowerSchool Holdings’ TRA waived their termination payment entirely to help close a $5.6 billion acquisition by Bain Capital.
If you’re sizing up a company with a TRA, the questions worth asking are straightforward. How large is the outstanding TRA liability relative to market capitalization? Who controls the board, and do those same people benefit from TRA payments? What happens to the TRA if the company is sold? The answers sit in the SEC filings, usually in the notes to the financial statements and in the full TRA agreement filed as an exhibit.
How Payments Are Taxed in the Recipient’s Hands
The tax treatment of TRA payments to former owners is less intuitive than it looks. Because the payments depend on future events and stretch across many years, the IRS treats the arrangement like a contingent payment debt instrument. Under Treasury regulations, the “noncontingent bond method” applies to instruments where payments are tied to uncertain future outcomes.8Internal Revenue Service. Revenue Ruling 2002-31
Under that method, interest is imputed on the obligation as if it were a fixed-rate debt instrument, using a “comparable yield” that cannot be less than the applicable federal rate. A projected payment schedule is built at inception, and each year the recipient recognizes imputed interest income on that schedule whether or not cash actually comes in. When actual payments diverge from the projection, the difference is adjusted: overpayments generate additional interest income, while underpayments can offset prior accruals or create ordinary losses.8Internal Revenue Service. Revenue Ruling 2002-31 Recipients can owe tax on imputed interest in low-cash years, and the character is ordinary rather than capital gain. Specialized tax advice is standard. The corporation making the payments has its own reporting obligations and may be entitled to deduct the interest component.