An Examination of the Final Carried Interest Regulations (Part Two of Two)

Carried interest arrangements are designed to give individuals employed by private fund managers a share in the profits realized by the managers’ funds. Those individuals then seek to treat those pass-through earnings as long-term capital gains for tax purposes, assuming those gains would otherwise be treated as capital gains. Preferential tax rates for capital gains realized by service professionals, however, are subject to extended holding period requirements. The Tax Cuts and Jobs Act, Section 1061 of the U.S. Internal Revenue Code (Section 1061) introduced a three-year holding period for long-term capital gains realized by service-provider partners instead of the one-year holding period that would otherwise apply. Recently published final regulations under Section 1061 (Final Regulations) create challenges for fund managers and their service providers that seek tax benefits from the partnership structure. In a guest article, the second in a two-part series, Allen & Overy attorneys Dave Lewis, Caroline Lapidus and Shoshana Schorr discuss the capital interest exception; the so-called “Look-Through Rule”; related person transfers; and reporting and compliance considerations, and it considers possible future changes to the law under the Biden administration. The first article provided the legal and legislative backdrop to the Final Regulations; compared the Proposed Regulations to the final version; and explained the Section 1061 recharacterization amount. See “The Tax Cuts and Jobs Act One Year Later – Updates and Structuring Considerations for Private Funds and Their Managers (Part One of Two)” (Feb. 14, 2019); and “Planning Strategies for Private Fund Managers Under the Tax Cuts and Jobs Act” (Jun. 7, 2018).

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