Treasury, IRS issue guidance on carried interest provision in tax law

The Treasury Department and IRS on Thursday issued a notice aimed at preventing investment-fund managers from avoiding new limits on the carried interest tax break.

Carried interest is the profits interest that investment-fund managers receive, and it is generally taxed at capital gains rates rather than the higher ordinary income rates.

Under a provision in the new tax law, investment-fund managers have to hold investments for at least three years in order to qualify for the carried-interest tax break, up from one year under the old tax code.

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But investments held by corporations are exempt from being subject to the three-year holding requirement. That reportedly led some hedge fund managers to set up S corporations — which are pass-through businesses rather than traditional C corporations — in order to avoid the requirement.

Treasury and the IRS said in their notice that they plan to issue regulations that prevent investments held by S corporations from being exempt from the three-year requirement. The agencies said that the regulations will be effective for tax years starting in 2018.

“We worked expeditiously to take this first step to clarify that S corporations are subject to the three year holding period for carried interest,” said Treasury Secretary Steven Mnuchin in a statement. “Treasury and the IRS stand ready to implement the Tax Cuts and Jobs Act as Congress intended and provide the appropriate taxpayer guidance on how the law will be implemented.”

The American Investment Council, which represents the private-equity industry, was positive about the new guidance.

“We appreciate the Treasury Department’s new guidance and believe it correctly clarifies the intent of the law on this tax provision,” said AIC president and CEO Mike Sommers.