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IRS to Close Carried Interest ‘Loophole’ Prompted by New Law

Posted on February 15, 2018 by William Hoffman

Fund managers using shell companies to avoid stricter limits on the use of carried interest aren't likely to see the tax benefits they were expecting.  

The IRS will be issuing guidance in the next two weeks that will prevent investment fund managers from using such maneuvers to sidestep the three-year holding period for assets created under the Tax Cuts and Jobs Act, Treasury Secretary Steven Mnuchin said February 14.

“We do believe that taxpayers will not be able to get that loophole by going through subchapter S” corporations, Mnuchin told the Senate Finance Committee, announcing the new IRS guidance schedule. “That’s something that we believe we have authority to do under the existing code,” he said.

Finance Committee ranking member Ron Wyden, D-Ore., cited media reports that hedge fund managers are creating shell companies to get around the law’s new requirements, calling the new tax law’s carried interest changes a “farce.”

The change in the length of the holding period from one year to three was made in the TCJA (P.L. 115-97) to quell concerns that investment fund managers were unfairly paying taxes on a huge share of their income at a 23.8 percent tax rate, rather than the top individual income tax rate that is now 37 percent. But critics have argued that the change in the holding period will have little practical effect because most private equity firms tend to already hold assets longer than that.  

“The truth is that the carried interest loophole will continue until we treat this money as ordinary income,” Rep. Sander M. Levin, D-Mich., said in a statement. “There is absolutely no reason that wealthy fund managers should pay a lower tax rate on their income derived from work than other Americans.” 

Farm Fix Talks Continuing

Separately during the hearing, Finance Committee Chair Orrin G. Hatch, R-Utah, complained that the TCJA's new section 199A passthrough business income deduction has been having unintended effects in agricultural markets because of its treatment of qualifying cooperative dividends.

Hatch said he would introduce legislation soon to address the bigger deductions granted to grain growers selling to agricultural cooperatives than when selling to independent businesses.

“The current statutory language [in the Tax Cuts and Jobs Act] does not maintain the previous competitive balance between cooperatives, other agricultural businesses, and the farmers who sell their crops to them, which existed prior to the . . . tax reform bill,” Hatch said.

Lawmakers have been negotiating the issue for weeks and working with farm groups such as the National Grain and Feed Association and the National Council of Farmer Cooperatives, but a solution has been tough to find so far. 

Hatch said he and Sens. Chuck Grassley, R-Iowa, John Thune, R-S.D., and Pat Roberts, R-Kan., are taking a leading role in identifying a solution “that does not pick winners and losers, and is fair to everyone involved.”

House Ways and Means Chair Kevin Brady, R-Texas, who is also working on a fix, has called the provision “a serious flaw in section 199A.”