In 2017, the Tax Cuts and Jobs Act altered the way carried interest, which is the portion of an investment fund’s returns that are paid to the managers, is taxed. According to Bloomberg Tax, the law requires the funds to hold assets for more than three years—up from one—for managers to get a preferential tax rate of 20% versus 37%, generally accompanied by an additional 3.8% net investment income tax.
As a result of this law, many investment funds began to alter their partnership agreements to structure carried interest in a manner that would potentially circumvent the new holding period. For example, one common technique funds used was placing carried interest waivers into agreements to grant fund managers the ability to waive short-term capital gain in exchange for a larger share of future gain.
The IRS has recently issued proposed regulations that directly address these types of strategies and warns that “taxpayers should be aware that these and similar arrangements may not be respected and may be challenged.” As a result, hedge funds and private equity managers will have to rethink the strategies utilized to mitigate taxes.
If you have any questions regarding these new carried interest rules or are directly affected by them, our experienced Investment Services Group can help ensure you are within compliance of IRS guidance. Contact Busch Mills to get started today.