New Proposed Tax Law Changes Under Biden Administration (Private Equity/Hedge Fund Venture Captial)
The Biden Administration has proposed several tax law changes including the following:
The topic we want to address specifically is the proposed change to the tax treatment of carried interest and its effect to the private equity/hedge fund and venture capital sector.
Under the Biden Administration, the preferential tax rates earned from “ISPIs” plan to be eliminated. ISPIs are profits of interest in an investment partnership that is held by a person who provides services to the partnership. With this plan, all income earned from carried interest allocations will be taxed as ordinary income and subject to self-employment taxes, if the taxpayer’s taxable income exceeds $400,000. With the Tax Cuts and Jobs Act in 2017, IRC Sec. 1061 states that property needs to be held for at least three years in order to receive capital gain rates earned from performing services through “applicable partnership interests” (APIs), pertaining to carried interests as well as profits interests.
As a result, the income earned from performing services will be taxed as ordinary income that will be subject to self-employment tax if the proposal is adopted. Since the Treasury requires that carried interests are from a performance of services, they will be subject to self-employment taxes as well. On the condition that the Self Employment Contributions Act becomes law, the new self-employment tax will be 15.4%.
The most impacted by this proposal would be private equity and venture capital general partners. In general, the securities that are held in these funds exceed the three-year holding period and are taxed at long-term capital gain rates. Even though it may not be necessary in some cases, general partners would want to think about changing their agreements and take their carried interest as a fee and not an allocation. In addition, general partners will not receive a benefit from donating appreciated securities earned through carry. However, private equity and venture capital funds will still have an advantage of deferrals of income and deemed contributions obligations.
Conversely, this proposal will have little impact on trader/475 funds. Since hedge fund general partners’ positions are not held for greater than three years, trader funds only pay ordinary rates on the majority of their carried interest as most of its income is short-term or taxed as short-term. Likewise, for investor hedge funds, not much is changing in the tax rate. Even so, limited partners in investor funds will still push for allocations as a means of not fully absorbing IRC Sec. 212 portfolio deductions that are currently not deductible on the individual and trust level.
One additional thing to note, funds with positions that are greater than three years have the option to decide to distribute cash in excess of basis to prompt long-term gain, take distributions-in-kind, or sell securities before year-end.
Finally, the Ending the Carried Interest Loophole Act that was introduced in the Senate-by-Senate Finance Committee Chair Ron Wyden (D-OR) and Senator Sheldon Whitehouse (D-RI) on August 5, 2021 can have major impact to the industry (private equity/venture captial/hedge fund). Under this proposal, a fund manager would be subjected to self-employment tax and be required to recognize a deemed compensation amount, yearly taxed at ordinary rates.
Since a change in tax policies always needs careful consideration and a thorough review, contact Bovell Financial to plan appropriately.
Bovell Financial | 09/22/2021