Carried interests have allowed investment fund managers to be compensated for services with income that qualifies as long-term capital gains, which is taxed at a lower rate than ordinary income. Numerous efforts have been made during the last two decades to cut back or eliminate the favorable tax treatment of carried interests by taxing all income from carried interests as ordinary income. The 2017 Tax Cuts and Jobs Act (TCJA) enacted Internal Revenue Code Section 1061, which did not eliminate the benefit of carried interests, but rather kept the prior tax treatment with new limits.

OVERVIEW OF SECTION 1061

Section 1061 increases the holding period required for longterm capital gains treatment from more than one year to more than three years for an “applicable partnership interest” (API). Section 1061(c)(1) defines an API as any interest in a partnership which, directly or indirectly, is transferred to, or is held by, the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any applicable trade or business. Prior to the enactment of Section 1061, taxpayers could claim long-term capital gains treatment through a passthrough loophole, as long as the carried interest was held for over a year. Today, this same taxpayer would have short-term capital gains (taxed at ordinary income rates), notwithstanding Section 83 or any election made under Section 83(b). It should be noted that the three-year holding period rule applies to capital gains recognized after 2017, regardless of when the taxpayer acquired the API. Section 1061(c)(2) defines the term applicable trade or business as any activity that is conducted on a regular, continuous, and substantial basis, regardless if such activity is conducted in one or more entities, and consists, in whole or in part, of...

This is a preview of one of the articles in the new KROST QUARTERLY Financial Services Issue, titled "New Capital Gains Treatment for Carried Interests" by Matthew Weber, CPA, MAcc. Click below for access to the publication.

KROST Quarterly is a digital publication that highlights some of the hot topics in the accounting and finance industry. Volume 2, Issue 3 highlights some of the hot topics in financial services including Sales Tax Nexus, QSBS, Carried Interests, Trader Tax Status, Family Office, and more.