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Carried interest tax rules slated for 2020, official says

The Treasury Department is planning to issue regulations restricting how hedge fund managers can claim a valuable tax break early next year, a top Treasury official said.

The regulations will likely bar money managers from using S corporations to take advantage of an exemption to new rules for carried interest contained in President Donald Trump’s tax legislation. The rules are slated for early 2020, David Kautter, Treasury’s assistant secretary for tax policy, said Wednesday at a American Institute of Certified Public Accountants event in Washington.

The regulations would address what some tax policy experts see as a mistake in the 2017 tax law that allows hedge fund managers to exploit a loophole to avoid paying higher taxes on their investments. The Treasury Department issued a statement in early 2018 that they planned to make the change to the carried interest rules.

David Kautter, assistant secretary for tax policy at the Treasury Department, testifies before the Senate Finance Committee.
David Kautter, assistant secretary for tax policy at the Treasury Department, testifies before the Senate Finance Committee.

Carried interest is the portion of an investment fund’s returns that are paid to hedge fund and private-equity managers, venture capitalists and certain real estate investors eligible for lower tax rates.

The tax law increased the time period hedge funds and private equity managers had to hold their investments to three years from one year to get the long-term capital gains rate of 20 percent. Otherwise, they had to pay individual income tax rates, which now top out at 37 percent.

But, tax law exempted corporations from having to hold assets for a longer time period before qualifying for the preferential tax rates. Hedge funds found a way to use that exemption by setting up a series of S corporations and limited liability companies for managers entitled to share carried-interest payouts to be eligible for the lower rates more quickly.

Some experts question whether the IRS has the authority to put this restriction in place through regulation, given that the tax law doesn’t include a limitation on the type of corporations that can access the tax break. A recent U.S. Court of Appeals ruling suggested the same, saying the IRS may struggle to defend the rules in future legal fights.

Laura Davison
Bloomberg News