Tax Reform Update: Impact on Private Equity, Hedge Funds, and Real Estate Partnerships

by DLA Piper
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Interesting tax update courtesy of Bruce Thompson, a Senior Policy Advisor with DLA Piper.  He continues to see momentum for comprehensive tax reform and wrote the following summary of what that might mean for fund managers and partnerships:

"The Chairmen of the Tax Committees in the House and Senate---Rep. Dave Camp and Sen. Max Baucus---are committed to moving a major tax reform bill, and the House leadership has reserved HR 1 for the tax reform bill.

Congressional tax writers are laying the groundwork for legislation that would lower individual and corporate tax rates and broaden the base by repealing or limiting many individual and corporate tax breaks. Both Chairmen have said that “everything is on the table,” and the nearly 200 tax expenditures are under review.

Major tax reform could also have a significant impact on private equity firms, hedge funds, and real estate partnerships. A number of proposals under consideration in the tax committees would involve major changes in the tax treatment of many investment management firms. These proposals include:

  • Taxing carried interest as ordinary income. The President has once again proposed taxing carried interest as ordinary income in his recent budget, and the proposal will be considered in the tax reform legislation. Consideration could also be given to a proposal to require owners of certain investment services businesses to pay tax at ordinary income rates on the gain from the sale of enterprise value.
  • Limiting the interest deduction for debt. A number of tax reform proposals call for limiting the interest deduction for debt. The President’s business tax reform report recommended reducing the deductibility of interest to reduce the tax code’s “bias toward debt financing.” Congressional tax writers are considering proposals to limit the interest deduction by a specified amount or by the value of inflation.
  • Taxing large partnerships and other pass-through entities as corporations. The President’s tax reform report said that many businesses are organizing as pass-through entities to avoid corporate tax liability, and said that taxing large partnerships as corporations would improve equity, reduce business distortions, and raise revenue to finance lower tax rates.
  • Revising partnership rules. Congressional tax writers are considering proposals to revise the tax rules applying to all partnerships, S corps, and limited liability corporations. Options under consideration would streamline and simplify some rules, while tightening others in order to limit  “the use of partnerships as tax avoidance structures,” according to a committee draft.
  • Taxing financial products. Congressional tax writers have released a discussion draft of proposals to reform the tax treatment of financial products. Proposals under consideration would impose mark-to-market accounting for financial derivatives, reform hedging tax rules, and revise the tax-basis calculation for securities sales. Committee documents say the proposals would “update and rationalize” tax rules, while opponents argue that taxing hedging strategies would penalize all investors.
  • Strengthening FATCA. Legislation has been introduced in the House and Senate to give Treasury new authority to prohibit US firms from doing business with any foreign jurisdiction or institution which is deemed to impede US tax enforcement efforts."

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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