Eliminating Carried Interest Tax Preference Proposed

On Feb. 6, President Donald Trump reinstated his support for eliminating the preferential tax treatment for carried interests to fund tax cuts. He originally proposed eliminating the preference when running for his first term as president, but when the TCJA was enacted, the preference was adjusted to require a three-year holding period but was not eliminated. After the president’s statement, Democrats in the House and Senate quickly introduced legislation to eliminate the preference.

Background

Individuals are taxed on long-term capital gains at lower rates than short-term capital gains, which are taxed as ordinary income. Currently, the highest tax rate for long-term capital gains is 20%, whereas the highest marginal tax rate for ordinary income of individuals is 37%. Prior to 2018, carried interests, which generally are a share of fund profits received by fund managers, were treated as long-term capital gains and taxed at lower long-term capital gains rates.

As far back as 2007, the tax treatment of carried interest has been of interest to Congress. Over the years, numerous proposals have been introduced to reform how carried interests are taxed, culminating in the enactment of Section 1061 as part of the TCJA.

As enacted by the TCJA, Section 1061 recharacterizes certain net long-term capital gains of a partner holding an applicable partnership interests as short-term capital gain. Applicable partnership interests generally are partnership interests that are transferred to or held by a taxpayer in connection with the performances of substantial services. Generally, the provision requires an applicable partnership interest to be held for more than three years for capital gain from such interest to be treated as long-term capital gain. Section 1061 is effective for taxable years beginning after Dec. 31, 2017.

Carried interest elimination as an offset

Recently, Trump has said that he supported eliminating the carried interest tax preference. The Congressional Budget Office has estimated that eliminating the carried interest preference would raise $13 billion, which Trump is hoping can pay for eliminating the tax on tips, overtime, and Social Security and allowing the $10,000 state and local tax cap to expire.

Crowe observation

The president’s renewed support for eliminating the carried interest preference caught many taxpayers by surprise and is expected to garner strong opposition.

Looking ahead

Fund managers are closely watching congressional action on the TCJA expiring provisions. Taxpayers should continue to work with industry groups and advisers to keep abreast of the latest developments and evaluate how potential legislative outcomes could affect them and how to mitigate potentially negative consequences.