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Tax Reform Impact on Investment Managers’ Carried Interest

16Feb

Tax Reform Impact on Investment Managers’ Carried Interest

By Michael Galvin

Topic that has garnered a lot of attention for fund managers of late has been the impact of the new tax law on carried interest. Under the newly enacted law, IRC Section 1061 of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, a general partner’s allocation of income that previously retained the long-term capital gains characteristics of the underlying investments in the partnership will now be treated as short-term capital gain. This short-term capital gain will be taxed as ordinary income, at a maximum rate of 37%.

Under the new law, if a partnership sells an asset that has been held for over a year, will be treated as long-term capital gains for the limited partners.  However, the allocation to the general partner will now be subject to short-term capital gains treatment, unless the asset was held for 3 years or greater. The new tax rules apply to those operating a trade or business that raises and returns capital relating to investments in securities, commodities, derivatives, and real estate.

The enactment of IRC Section 1061 under the Tax Cut and Jobs Act has forced investment managers to consider what type of fund structure and investment holding period allows for maximum return. As fund managers assess future decisions to deploy capital, the impact of current changes to carried interest must be included in the decision-making process.