In 2017, the Tax Cuts and Jobs Act (TCJA) was ushered through Congress and signed by President Trump. One of the items on the tax reform agenda was limiting the so-called “carried interest tax break,” and, ultimately, the TCJA extended the holding period from one year to three years for an investment manager to receive beneficial long-term capital gain tax rates on their profits interest (also referred to as “carried interest”).
 
However, the lightning speed at which the new tax law was drafted left the finished product with many unintended consequences. Before the end of 2017, creative structuring techniques were already being implemented to exploit the ambiguity in the tax code that exempted corporate entities from the increased holding period requirements. The term “corporation” was not defined and allowed investment managers to use S Corporation structures — treated as pass-through entities similar to partnerships for tax purposes — to obtain the beneficial long-term capital gain treatment with the one-year holding period.
 
Upon learning of this work-around, the Treasury and the Internal Revenue Service (IRS) issued Notice 2018-18 clarifying that S Corporations are subject to the three-year holding period, effectively closing this short lived loop-hole. The Treasury and the IRS intend to issue official regulations in the near future that will be effective for the 2018 tax year. 
 
Treasury Secretary Steven Mnuchin stated “Treasury and the IRS stand ready to implement the Tax Cuts and Jobs Act as Congress intended and provide the appropriate taxpayer guidance on how the law will be implemented.” Based on this statement, we can anticipate additional regulations that attempt to clarify and possibly tie up any loose ends overlooked in the TCJA.
 
For additional planning opportunities regarding carried interest, see our prior blog post on carried interest reform. 
 
Please contact a member of your service team, or contact Cynthia Pedersen at cynthia.pedersen@cohencpa.com or Peter Gilroy-Scott at peter.gilroy-scott@cohencpa.com  for further discussion.

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.