July 31, 2020
BREAKING TAX NEWS | IRS issues proposed carried interest regulations on recharacterizing long-term capital gain for certain partners performing substantial services
The IRS has issued proposed regulations (REG-107213-18) under IRC Section 1061, which recharacterizes as short-term capital gains certain net long-term capital gains of a partner holding one or more applicable partnership interests (APIs). An API is defined as a partnership interest that is transferred to, or held by, a taxpayer in connection with the performance of substantial services by the taxpayer or any related person in an applicable trade or business.
The proposed regulations provide some clarifications on how to apply IRC Section 1061. In part, the proposed regulations:
The Preamble to the proposed regulations cautions taxpayers against carry waivers or carried-interest waivers, as these and similar arrangements may not be respected and may be challenged under IRC Section 707(a)(2)(A), Treas. Reg. Sections 1.701-2 and 1.704-1(b)(2)(iii), and/or the substance-over-form or economic-substance doctrines.
A 60-day period is being provided for public comments and requests for a hearing. Taxpayers and partnerships may rely on the proposed regulations for tax years beginning before the final regulations are published in the Federal Register, as long as they consistently follow the proposed regulations in their entirety. The proposed regulations would apply for tax years beginning after December 31, 2017, for the exception under IRC Section 1061(c)(1) to the definition of an API not applying to a partnership interest held by an S corporation.
The proposed regulations would affect investment funds, including private equity and alternative asset funds (i.e., hedge, real estate, energy, infrastructure, and fund of funds), and the managers and general partners of these funds.
A Tax Alert is forthcoming.