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June 9, 2021

Biden Administration's budget and Green Book proposals address partnership issues relevant to alternative asset management funds and energy operating partnerships

The Biden Administration's FY2022 budget and Treasury Green Book propose several changes to rules affecting partnerships such as private equity funds, alternative asset management funds (e.g., hedge, debt and real estate funds) and energy operating partnerships, including:

  • Taxing carried interest as ordinary income
  • Eliminating the exemption for fossil fuel publicly traded partnerships (PTPs)
  • Expanding the application of employment taxes to income of certain limited partners
  • Making push-out adjustments under the centralized audit regime refundable

Carried interest

The Administration's proposal would generally tax as ordinary income a partner's share of income on an "investment services partnership interest" (ISPI) in an investment partnership, regardless of the character of the income at the partnership level, if the partner's taxable income (from all sources) exceeds $400,000. Accordingly, this ISPI-related income would not be eligible for the reduced rates that apply to long-term capital gains. The gain recognized on the sale of an ISPI would generally be taxed as ordinary income, not as capital gain, if the partner is above the income threshold.

The proposal would repeal IRC Section 1061 for taxpayers with taxable income (from all sources) over $400,000 and would be effective for tax years beginning after December 31, 2021 (for more details on IRC Section 1061, see Tax Alerts 2021-0291 and 2020-2026). The Green Book states that the proposal is not intended to adversely affect the qualification of a real estate investment trust owning a profits interest in a real estate partnership.

The proposal appears similar to other carried interest proposals1 (other than retaining the newly enacted IRC Section 1061 requirements for taxpayers with taxable income of $400,000 or less). In addition, the Administration's proposal would require partners in investment partnerships to pay self-employment taxes on that income.

The Green Book appears to focus on the issue of enterprise value in the context of sales of management company businesses, providing "the Administration remains committed to working with Congress to develop mechanisms to assure the proper amount of income recharacterization [when] the business has goodwill or other assets unrelated to the services of the ISPI holder."

Comment: Carried interest reform might be redundant considering the Administration's proposal to increase capital gains rates to ordinary income rates for high-income taxpayers, beginning on the "date of announcement" (a somewhat ambiguous reference in the Green Book, but possibly as early as April 28, 2021). If the preference for long-term capital gain ends, the Administration's carried interest proposal would only affect a narrow subset of carried-interest recipients, namely profits-interests holders with taxable income below $1 million (the threshold in the long-term capital gain proposal) and above $400,000 (IRC Section 1061 would still apply to those with income from all sources of $400,000 or less). This limited, partial repeal of IRC Section 1061 would lead to new tax complexities and compliance burdens as two different regimes could apply to the same partnership, depending on the income thresholds of the partners.

The Administration's proposal differs from existing carried interest rules (IRC Section 1061 and its regulations) in several ways:

  • The proposal converts what is otherwise long-term capital gain into ordinary income (IRC Section 1061 converts certain long-term capital gains into short-term capital gains taxed at ordinary rates)
  • The treatment as ordinary income would apply regardless of the holding period (IRC Section 1061 generally applies to gains on dispositions of assets held for three years or less)
  • Self-employment taxes would apply to such income

Private equity, private capital, and other alternative asset management funds and their professionals could face increased tax liabilities if either the carried interest proposal or the proposal to increase capital gains rates is enacted.

Oil and gas PTPs

Among many proposed changes related to fossil-fuel taxation, the Administration proposes repealing the exemption from corporate income tax for PTPs with qualifying income from exploring for, refining, transporting, marketing and extracting natural resources. PTPs generating such income would be classified as a corporation.

The repeal would be effective for tax years beginning after December 31, 2026.

Expanding SECA application to income of certain limited partners

The Administration would generally impose SECA taxes on distributions of partnership income to an individual who (1) is a limited partner or a limited liability company (LLC) member in a partnership and (2) provides services and materially participates in the partnership. SECA would apply to the extent the partner's or member's income exceeds certain threshold amounts. Current SECA exemptions for certain types of partnership income (e.g., rents, dividends, capital gains and certain retired partner income) would continue to apply.

The proposal would be effective for tax years beginning after December 31, 2021.

This proposal is the latest in a series of attempts to eliminate the SECA exemption for income of certain limited partners (also known as the "limited partner exception"). Though the proposal's prospects for enactment remain uncertain, private funds and their management companies should continue to monitor its progress, as its enactment could increase the employment tax liability of their professionals and impact their tax structuring and choice of entity.

Amending centralized partnership audit regime

Under current law, a partnership subject to audit can either choose to pay any imputed underpayment of tax at the partnership level or elect to "push out" the audit adjustments to its reviewed-year partners. If those adjustments result in a net tax decrease for the reviewed year, the reviewed-year partners may use that decrease to reduce their reporting year income tax liabilities. The adjustments may not, however, reduce the partner's reporting year tax liability below zero and may not be carried over to future years. Accordingly, any excess amount not offset with income tax due in the reporting year appears to be permanently lost.

The same rules apply when a partnership files an Administrative Adjustment Request (AAR) to make corrections to an originally filed partnership return. In fact, the potential for a permanent loss of a partner-level overpayment is more likely to occur in the AAR context, as partnerships must "push out" favorable AAR adjustments.

IRC Sections 6226 and 6401 would be amended to treat a net negative change in tax that exceeds the income tax liability of a reviewed-year partner in the reporting year as an overpayment under IRC Section 6401 that may be refunded. The proposal would be effective upon enactment.

Comment: This proposal indicates a willingness to address what appears to be an inherent inequity in the current regime. Funds and their partners would welcome this change, as BBA AARs are commonplace and often a necessity (especially in the fund-of-funds space) due to the late receipt of underlying partnership Schedule K-1s. Absent a fix to current law, a BBA AAR that results in an overpayment of tax could result in a potential permanent loss of an overpayment of tax.


The prospect for enactment of the Administration's proposals is unclear. Nevertheless, the Green Book indicates that the Administration is interested in making numerous changes to the taxation of the income from fossil fuel activities and income earned through pass-through entities by active service providers.


Contact Information
For additional information concerning this Alert, please contact:
Partnership Transactions Group
   • Jeff Erickson (
FSO – Private Equity Tax
   • Gerald Whelan (
   • Morgan Anderson (
Tax Controversy Practice
   • Alice Harbutte (
   • Melissa Wiley (
Private Client Services
   • David Kirk (


1 See e.g., former Representative Sander M. Levin's Carried Interest Fairness Act of 2019 (H.R. 1735) (one of many such bills introduced by Representative Levin over the years); the Carried Interest Fairness Act of 2021 (H.R. 1068), introduced by House Ways and Means Committee member Bill Pascrell Jr., D-N.J.; and, as part of a 2020 bill, the Stop Wall Street Looting Act (S. 2155), introduced by Senate Finance Committee member Elizabeth Warren.