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Carried Interest May Need to Head Back to Congress

Posted on January 24, 2018 by Stephanie Cumings

It’s unclear if the carried interest provision in the new tax law is intended to apply only to C corporations or to S corps as well.

The IRS may not be able to fix the oversight in guidance if the problem isn’t addressed by Congress in technical corrections, according to practitioners.

Lisa Sergi of Deloitte Tax LLP said January 23 that there have been huge disagreements at her firm on whether S corps are subject to the new section 1061 in the Tax Cuts and Jobs Act (P.L. 115-97). The new provision extends the holding period requirement from one year to three years to get the more favorable long-term capital gains treatment on gains regarding applicable partnership interests. Sergi said the private equity industry believes it dodged a bullet with what she called a pretty watered-down provision. “It’s carried interest legislation for people who didn’t really want to do carried interest legislation,” she said at an event hosted by the New York State Society of CPAs in New York.

Sergi noted that under the new law, the term “applicable partnership interest” doesn’t include “any interest in a partnership directly or indirectly held by a corporation.” She said that because the statute just says “corporation,” some have assumed this includes S corps, and thus that section 1061 doesn’t apply to S corps. However, Sergi said other practitioners believe this language is an oversight and that Congress didn’t intend S corps to be included when they used the term “corporations.”

“I personally think it was most likely a drafting error,” which the government will need to correct, said David S. Untracht of Untracht Early LLC. But he added that he doesn’t know if the IRS can release guidance to simply say that Congress “didn’t mean all corporations,” just C corps. Many taxpayers have since been setting up single-member limited liability companies to potentially make an S corp election by the March 15 deadline, Untracht said. Congress or the IRS almost certainly won’t be able to resolve this issue by then, so taxpayers will have to proceed without a definitive answer, he added.

Monte A. Jackel of Akin Gump Strauss Hauer & Feld LLP raised the issue with S corps last November, before the provision was signed into law, and warned that these kinds of fixes shouldn’t be left to technical corrections or regulations.

White House National Economic Council Director Gary Cohn recently said he wished Congress had gone further and eliminated the ability of investment fund managers to treat carried interest income as a capital gain, rather than as ordinary income. He said carried interest was an issue of particular concern to the president.