A tax receivable agreement, often abbreviated TRA, is a contract between a newly public corporation and its former owners that splits the value of future tax savings created when a partnership or LLC converts into a corporate structure through an IPO. The standard split sends 85% of the realized cash tax savings to the former owners and keeps 15% for the corporation, with payments running over roughly 15 years as the underlying tax deductions are used.1Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements These agreements appear almost exclusively in a specific IPO structure known as an Up-C, and the resulting obligation can sit on a public company’s balance sheet at hundreds of millions of dollars.
Why the Agreement Exists
TRAs come out of a mismatch between how partnerships and corporations are taxed. In a partnership or LLC, profits flow through to the owners, and the entity’s tax basis in its assets often lags far behind what the ownership interests are actually worth after years of growth. The Up-C IPO structure preserves that gap and then lets the new corporation close it.
Here is how the structure works. The former owners don’t sell their partnership units in the IPO. A new holding company, usually called PubCo, is placed 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 the Class B shares and can later exchange units for Class A shares one-for-one.
Each exchange triggers a tax basis adjustment. Under an election available in Section 754 of the Internal Revenue Code, the partnership steps up the tax basis of its underlying assets to reflect the fair market value of the exchanged interest.2Office of the Law Revision Counsel. 26 USC 754 The mechanics run through Section 743(b), which raises the partnership’s asset basis by the difference between what the transferee paid and their share of the partnership’s existing basis.3Office of the Law Revision Counsel. 26 US Code 743 – Special Rules Where Section 754 Election or Substantial Built-In Loss For intangibles like goodwill, Section 197 spreads that stepped-up basis as amortization over 15 years.4Office of the Law Revision Counsel. 26 US Code 197 – Amortization of Goodwill and Certain Other Intangibles Those extra amortization and depreciation deductions reduce the corporation’s taxable income year after year. The TRA governs how the resulting tax savings get divided.
Where the 85/15 Split Came From
The 85% figure is not calculated. It is the market convention, and it appears in nearly every Up-C IPO prospectus.1Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements The logic is a negotiated compromise. The basis step-up only exists because the former owners agreed to the Up-C structure, so a straight 100% retention by the corporation would effectively hand value from the original owners to new public shareholders. The 15% retention gives the public company some upside and an incentive to manage its tax position efficiently.
How the Annual Payment Is Calculated
TRA payments are not fixed installments. Each year, the corporation computes a hypothetical tax bill assuming none of the basis step-up deductions existed, then compares that to its actual tax liability. The gap is the cash tax savings for the year, and the corporation pays 85% of that number to the TRA beneficiaries.
The federal corporate rate of 21% is the starting input, but state and local income taxes matter too.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 the TRA math is often meaningfully higher than 21%. The specific rate assumption is set in the agreement itself and disclosed in public filings.
Payment timing usually tracks the filing of the corporation’s annual income tax return, once the actual liability is finalized. Deferred or late payments typically accrue interest at a benchmark rate, commonly 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 savings are realized, so no TRA payment is owed for that year. The unused deductions carry forward and can be applied in later profitable years. That contingency is the real risk former owners take: if the company never generates enough income to consume the tax attributes within the contract period, the payments never come.
Tax Rate Changes
Because the payment is a percentage of realized tax savings, any legislative move in the corporate rate flows straight through. A rate increase makes each dollar of deduction worth more and expands the payment stream. A rate cut shrinks it. That produces the unusual result that TRA beneficiaries have a financial interest in higher corporate tax rates while public shareholders may prefer lower ones.
What Happens if the Company Is Acquired
Under normal operations, TRA payments trickle out over 15 years and depend on profitability. A change of control changes the picture entirely. Most TRAs contain acceleration clauses triggered by a merger or acquisition, and when triggered, the corporation owes an immediate lump sum equal to the present value of all remaining expected payments.7U.S. Securities and Exchange Commission. Tax Receivable Agreement – Birkenstock Holding plc
The assumptions inside that lump-sum number tend to favor the recipients. The calculation assumes 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 modest, often SOFR plus 100 basis points, so the present-value haircut is small. The math also ignores limitations that may actually apply after the deal, including the annual limits Section 382 imposes on tax attribute use following ownership changes.7U.S. Securities and Exchange Commission. Tax Receivable Agreement – Birkenstock Holding plc
The upshot is that an acceleration payment can far exceed what beneficiaries would have received under normal operations, and acquirers price that cost into any deal. Some agreements also let the corporation itself elect to terminate early, buying out the obligation for a lump sum calculated on similar assumptions.
What This Means for Public Shareholders
The main concern with TRAs is incentive alignment. When a private equity sponsor or founder controls the public company and also holds TRA rights, a sale converts the agreement into a large immediate payout that minority shareholders don’t share in. A Delaware Chancery Court addressed this 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 at odds with minority shareholders’ best interests.
Real examples show the range of outcomes. In 2022, GoDaddy’s board faced a shareholder lawsuit over a plan to pay roughly $850 million to the company’s founder and private equity backers under a TRA, well above the $175 million carrying value of the obligation on the audited financial statements. At 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 are evaluating a company with a TRA, three questions do most of the work. How large is the outstanding TRA liability relative to market capitalization? Who controls the board, and do those same people receive TRA payments? And what does the agreement say about acceleration on a sale? All of it is disclosed in SEC filings, in the notes to the financial statements and in the full TRA filed as an exhibit.
One accounting quirk is worth flagging. Changes in expected future tax savings, whether from revised income projections, new exchanges, or enacted tax rate changes, force a remeasurement of both the deferred tax asset and the TRA liability, and those adjustments run through the income statement rather than equity.1Deloitte Accounting Research Tool. 7.14 Tax Receivable Agreements That can produce non-cash gains or losses that swing reported earnings for reasons that have nothing to do with core operations.
Tax Treatment for Payment Recipients
If you are on the receiving end of a TRA, the tax treatment is less straightforward than the cash flow suggests. Because payments are contingent on future events and stretch over years, the IRS treats the arrangement like a contingent payment debt instrument and applies the noncontingent bond method under Treasury regulations.8Internal Revenue Service. Revenue Ruling 2002-31
Under that method, interest is imputed on the obligation using a comparable yield that cannot be lower than the applicable federal rate, and a projected payment schedule is constructed at inception. Each year, the recipient recognizes imputed interest income based on that schedule whether or not cash is received. When actual payments diverge from the projections, the difference adjusts interest income upward or offsets prior accruals, potentially creating ordinary losses.8Internal Revenue Service. Revenue Ruling 2002-31
The practical consequence is that recipients can owe tax on imputed interest in years when little or no cash actually arrives, and the character is ordinary rather than capital gain. Most recipients rely on specialized tax advisors to model the annual consequences. The corporation may also be entitled to deduct the interest component of the payments it makes.