How Tax Receivable Agreements Work: Payments, Duration, and Termination

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 tax savings it later realizes from certain tax attributes created by the IPO restructuring. In the standard version, the corporation keeps 15% of those cash tax savings and pays 85% back to the former owners each year the savings are actually used on a tax return.

Where the Tax Savings Come From

Most TRAs trace back to an “Up-C” IPO. Instead of converting a partnership or LLC into a corporation, a new corporation (often called PubCo) is formed on top of the existing operating partnership. PubCo sells shares to the public, uses the cash to buy into the partnership, and the pre-IPO owners keep their partnership units with the right to swap them later for PubCo stock. Each swap is a taxable event that produces new tax deductions for PubCo.¹

Those deductions don’t appear automatically. The operating partnership has to file a Section 754 election, which lets it adjust the tax basis of its assets whenever a partner transfers an interest.² With the election in place, each unit exchange triggers a basis step-up under Section 743(b). If the partnership’s assets have appreciated well beyond their original cost, the step-up closes that gap for PubCo’s share of them, producing larger depreciation and amortization deductions that reduce PubCo’s taxable income going forward.

Two tax attributes carry most TRAs. The first is that basis step-up. When it’s allocated to intangibles like goodwill, the amortization runs 15 years under Section 197.³⁴⁵ Some agreements also sweep in tax credits or the imputed interest deductions generated by the TRA payments themselves, but the step-up and NOLs drive the bulk of the value.

How Each Year’s Payment Is Calculated

A TRA pays out only when the corporation actually uses the covered attributes to reduce a real tax bill. A deduction on paper produces nothing until there’s taxable income to offset. That is what makes TRA payments contingent rather than fixed.

Each year the company runs two calculations: its actual federal (and usually state) tax liability using every available deduction, and a hypothetical liability calculated as if the TRA-covered attributes didn’t exist. The gap between the two is the realized cash tax savings for the year. The TRA payment is a contractual percentage of that gap, and in nearly every public deal that percentage is 85%.⁶

A quick example. Suppose PubCo would owe $10 million in tax without the TRA-covered attributes and $2 million with them. Cash tax savings are $8 million. At 85%, the former owners receive $6.8 million and PubCo keeps $1.2 million. That $1.2 million is PubCo’s own permanent cash benefit, and it’s the reason the corporation is willing to sign the agreement in the first place.

If PubCo has no taxable income in a given year, there are no realized savings and no payment is due. The deductions don’t vanish; they carry forward. But the former owners get nothing until a profitable year uses them.

How Long the Obligation Lasts

A TRA runs as long as the covered attributes keep producing deductions. Payments tied to goodwill and other Section 197 intangibles stretch across the 15-year amortization period.³ Payments tied to NOLs with indefinite carryforwards can run even longer. The agreement terminates only after every covered attribute has been used or has expired.

Payments are usually made annually, a few months after PubCo files its federal return. Late payments generally accrue interest, and most agreements name an independent accounting firm as the tiebreaker if the two sides disagree on the calculation.

Early Termination and the Acceleration Payment

The most expensive feature of a TRA is what happens if it ends early. Nearly every agreement converts the entire remaining obligation into a single lump sum on certain trigger events. The most common trigger is a change of control (PubCo being acquired or merged), and a material breach of the agreement can also trigger acceleration.

The accelerated amount is the present value of every estimated future payment, discounted at a rate set in the agreement. In filings, that rate is often the lesser of a fixed cap around 6.5% or a floating benchmark such as SOFR plus 100 basis points.⁷

What makes the acceleration payment particularly harsh is the set of “valuation assumptions” built into the calculation. Standard drafting requires PubCo to assume it will earn enough taxable income to fully use every remaining attribute over its full statutory life, and that current tax rates will hold.⁷ The lump sum can easily exceed what the company would have paid across the natural life of the agreement, because the assumptions project a future rosier than actual results are likely to deliver. For an acquirer pricing a deal, the TRA acceleration payment is a hard cost that can run into hundreds of millions of dollars.

What Can Shrink, Delay, or Inflate Payments

Because payments track real tax outcomes, a handful of real-world events can move them significantly in either direction.

Not Enough Taxable Income

The simplest risk is a company that doesn’t make enough money. If PubCo is unprofitable or already has other large deductions, the TRA attributes sit unused and no payment is triggered. They carry forward, but former owners bear the genuine risk that full utilization may never happen. A growth-stage company that goes public through an Up-C with aggressive projections can generate little or no TRA value for years if the growth doesn’t materialize.

Section 382 Ownership-Change Limits

An IPO can itself trigger a limit that shrinks the annual value of NOLs covered by the TRA. Section 382 caps how much of a company’s pre-change NOLs it can use each year after an “ownership change,” defined as one or more 5-percent shareholders increasing their combined ownership by more than 50 percentage points inside a rolling three-year window.⁸ In an IPO, the new public shareholders are treated collectively as a single 5-percent holder, so their combined stake can push through that threshold even if no one investor is close.

The annual cap equals the company’s fair market value immediately before the ownership change multiplied by the federal long-term tax-exempt rate published monthly by the IRS.⁸ If the cap is lower than what the company could otherwise use in a year, the rest carries forward. That stretches the TRA payment timeline and reduces the present value of the obligation. The basis step-up is generally not subject to the same annual cap because it arises from a new transaction rather than a pre-change loss.

Changes in Tax Law

The federal corporate tax rate is a direct multiplier on every payment. At the current 21% rate, a $100 million basis step-up generates $21 million in total tax savings across the amortization period. Raise the rate to 28% and the same step-up produces $28 million, a 33% increase in TRA payments. A rate cut works the other way. Changes to the NOL rules (a return to time-limited carryforwards, a tighter than 80% utilization cap) could keep some covered deductions from ever being used. State rates matter too, since most TRAs cover state and local income tax savings; state corporate rates run from roughly 2% to nearly 12%.

Audits and Adjustments

The IRS or a state authority may challenge the basis step-up or the amount of NOLs. If an audit disallows part of the benefit, the tax savings shrink retroactively. Most TRAs handle this through “true-up” provisions that adjust future payments to reflect the reduced benefit, and some include explicit clawback language for overpayments. The recovery mechanics (escrow, indemnification, offsets against future payments) depend entirely on how the individual agreement is drafted.

How TRAs Show Up in the Financials

For anyone reading a filing, a TRA is worth finding in the notes. Under U.S. GAAP, the accounting sits primarily within ASC Topic 740 on income taxes.⁹ When a pre-IPO owner exchanges units for PubCo stock, PubCo records a deferred tax asset for the future benefit of the step-up and a TRA liability for the contractual obligation to pay 85% of that benefit. Both flow through equity at inception (a reduction of additional paid-in capital), not through the income statement, because they arise from an equity transaction.⁶

After that, the TRA liability is remeasured each reporting period and any change runs through the income statement. A downward revision in the forecast of future taxable income shrinks the liability and produces a reported gain. A corporate rate increase enlarges the estimated future savings and produces a reported loss. Companies classify these remeasurement swings differently, some in other income and expense, others inside the income tax provision, so the footnotes are worth checking. Public filers must disclose the key TRA terms, the projected payment schedule, the critical assumptions, and the payments made during the period.

Read together, those disclosures are the fastest way to see how large the obligation is, how sensitive it is to tax rates and profitability, and how badly a change-of-control acceleration would hit if the company were sold.

1
Deloitte. Up-C Structure For Pass-Through Entities
2
Office of the Law Revision Counsel. 26 USC 754 – Manner of Electing Optional Adjustment to Basis of Partnership Property
3
Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles
4
Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction
5
Internal Revenue Service. Instructions for Form 172 – Net Operating Losses
6
DART – Deloitte Accounting Research Tool. Statement of Cash Flows – Tax Receivable Agreements
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