Highlights of Certain New Tax Considerations for Investment Funds and US Businesses (Part 1)

Update: Changes in the US Federal Tax Law 2018 (Part 1 – Impact on Investment Funds)

On December 22, 2017, the President signed the bill formerly known as the Tax Cuts and Jobs Act (the “Act”). The Act significantly changes some crucial domestic and international tax rules.  

The Act includes a large reduction in the corporate tax rate from 35% to 21% and a major change in international tax to a hybrid participation exemption system that reduces and sometimes eliminates tax on profits of foreign operations.  The Act also modifies the effective rate for individual owners of businesses in LLCs and other pass-through entities with a reduction as much as 20% in some instances.

Impact on Certain Alternatives Funds including Hedge Funds and PE Funds that hold medium term assets

A number of The Act provisions could impact hedge funds, PE funds and other alternative funds.   These include a new three-year holding period to be eligible for long-term capital gains treatment with respect to carried interests as well as a new limitation on the deductibility of interest and the repeal of the ability to carryback net operating losses.  

The Act increases the holding period before a taxpayer would qualify for long-term capital gain rates with respect to certain carried interests from one year to three years. Such partnership interests would include partnership interests received in connection with the performance of substantial services in a trade or business relating to (i) raising or returning capital, and (ii) either investing in (or selling) certain securities, commodities, real estate, cash or cash equivalents, or derivatives or developing such assets.

For investors in companies, the 20% deduction applicable to non-excluded passthrough businesses (described more fully in Part 2 of our Update) is available with respect to the income earned by non-corporate taxpayers through a fund’s portfolio companies that are owned in pass-through form. Such companies must have adequate W-2 wage income or qualified property.