November 9, 2010
Many active participants in partnerships and limited liability companies (LLCs) may face significantly higher income tax burdens if the Senate agrees to legislation, which has passed the House several times in the last couple of years. The legislation would cause certain partners to pay taxes on their income at a much higher rate than other partners. The legislation is directed at investment services partnership interests (ISPIs), commonly known as "carried interests" or "profit interests," and is aimed at individuals who make their living in the real estate, venture capital, and/or private equity businesses.
On September 16, 2010, Senate Finance Committee Chairman Max Baucus (D-Mont.) introduced the Job Creation and Tax Cuts Act of 2010, also known as the “extenders" and “carried interest" legislation ("the bill"). Generally, each year Congress passes a law that extends tax provisions set to expire in the current year. As proposed, the bill revives “carried interests" as a means for paying for the extenders. Carried interest legislation originally passed the House on May 28th. In the Senate after more than a week of extensive debate, a few amendments, and three failed cloture votes, the Senate shelved the legislation. However, the new version removes an unrelated controversial provision that makes a successful cloture vote more likely.
As drafted in the most recent Senate amendment, the provisions impacting ISPIs will be effective for all taxable years beginning after December 31, 2010. In addition, to the taxpayer’s allocable share of income from the partnership, any sale of an ISPI or distribution of appreciated property in 2011 or later will be subject to the new law. There is no distinction for partnership interests acquired before or after the date of enactment. Consequently, a transaction resulting in a long-term capital gain being recognized in 2010 would be subject to a federal tax rate of 15%. If it is recognized in 2011 or later it could be subject to a federal rate of over 37.5 percent -- more than 150 percent higher.
To assist with compliance the bill grants the IRS authority to double to 40 percent the penalties related to the understatement of tax attributable to avoidance of this new legislation.
As with most change, which will occur if the bill is enacted, there are opportunities to minimize and possibly eliminate the impact with proper planning and/or restructuring between now and the effective date.
Disclosure: The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan, or arrangement to any other party.
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