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A carried interest (also known as a profits interest) is:
An interest in a partnership (or LLC taxed as a partnership)
Typically granted to a service provider who provides managerial or advisory services to or on behalf of the partnership
Which, on the date of grant, would not entitle the holder to any share of liquidation proceeds if the partnership’s assets were sold for fair market value, its liabilities repaid, and liquidating distributions made to its partners
According to the House Ways and Means Committee, the bill is intended to
prevent investment fund managers from paying taxes at capital gains rates on investment management services income received as a carried interest in an investment fund
require them to treat carried interests as ordinary income received in exchange for the performance of services to the extent that the carried interest does not reflect a reasonable return on invested capital
continue to tax carried interests at capital gains rates to the extent that the carried interest reflects a reasonable return on invested capital
Actual scope is much broader
Would fundamentally change the way most carried interests are taxed, including carried interests in real estate partnerships
If a partnership distributes appreciated property to the holder of an ISPI, gain that the partnership would have recognized on sale of the asset is treated as an increased distributive share to the holder, taxable as ordinary income
Holder of the ISPI is treated as receiving a distribution of money to extent of the FMV of distributed property, resulting in gain recognition to the extent the deemed distribution of cash exceeds the holder’s tax basis in the partnership interest
An “anti-abuse” rule applies under certain circumstances where a person providing investment management services through a partnership participates in the appreciation in value of assets managed by the partnership through an entity other than the partnership.
Example: A hedge fund manager performs investment management services for the fund. The manager holds stock in a Cayman Island corporation that is a partner in the fund, and the value of the stock (or dividends) is substantially related to the assets managed by the fund. Dividends and gain on sale of the stock are recharacterized as ordinary income.
An ISPI is not treated as a qualified capital interest to the extent it is acquired by the service provider with proceeds of a loan made or guaranteed by any other partner or the partnership or by a person related to another partner or the partnership
In testing significance of non-service partners’ qualified capital interests in relation to the qualified capital interest of a service provider, include amounts loaned or guaranteed by a non-service partner or a related party to the non-service partner in that partner’s qualified capital interest
Purchaser of an ISPI in a taxable transaction succeeds to the transferor’s qualified capital account.
All amounts recharacterized as ordinary income or ordinary loss under Section 710 are taken into consideration in determining the self-employment tax liability of the holder of the ISPI (including amounts that would otherwise be treated as gain on sale of assets)
Recipient of a profits interest in consideration of the performance of services is deemed to have made a Section 83(b) election unless the recipient affirmatively elects otherwise
Absent election to not have Section 83(b) election apply, recipient must take the excess, if any, of the FMV of the ISPI over its acquisition cost into income in the year in which the profits interest is issued
Liquidation value is to be used for purposes of determining the FMV of a partnership interest received in connection with the performance of services