AICPA Provides Comments on Carried Interest Proposed Regulations

• December 2, 2020
• Carey M. Heyman, CPA

On July 31, 2020, the Department of the Treasury and the IRS issued proposed regulations under Section 1061, better known as the carried interest rules.  

A carried interest is the right to receive a share of the profits of a partnership, in which the holder does not have a right to receive money or other property, upon the immediate liquidation of the partnership at its current fair market value. In other words, a carried interest is given in exchange for services rendered to certain securities and real estate investment partnerships.

The purpose of Section 1061 is to prevent the transmutation of ordinary income into long-term capital gain. Section 1061, which was added to the Internal Revenue Code by the Tax Cuts and Jobs Act of 2017, changed the holding period for favorable long-term capital gain treatment in certain circumstances from one year to three years.

Last week, the AICPA submitted their concerns regarding the applicability and statutory authority under the proposed regulations and provided the Department of the Treasury and the IRS with eight recommendations:

• Provide a definition for an interest that is commensurate with capital contributed. The proposed regulations assume the entire partnership interest issued to the carry partner is an applicable partnership interest. Certain allocations of gains and losses are excluded from recharacterization.
• Remove the capital interest exception loan rule.
• Expand the unrelated purchaser exception.
• Correct the recharacterization amount calculation. The calculation in the proposed regulations include net long-term capital gains, but does not include net long-term capital losses, which can result in an overstatement of the recharacterization.
• Eliminate mandatory revaluations for tiered partnership structures. The proposed regulations require tracing unrealized gains and losses to the lowest level in tiered partnership structures by requiring mandatory revaluations for Section 1061 purposes. 
• The application of Section 1061(d) should remain limited to taxable transfers. This provision in the proposed regulations would convert some otherwise nontaxable transfers into taxable events, which would be contrary to the legislative intent of Section 1061.
• Ease and clarify reporting requirements. The proposed regulations introduce significant reporting requirements for passthrough entities that grant an applicable partnership interest, including passthrough entities that are part of a tiered partnership structure. It was recommended that upper tier passthrough entities be permitted to use a reasonable basis to estimate amounts for lower tier passthrough entities.
• Implement a transition rule for partnerships in existence on or before January 1, 2018.

Major kudos to my colleague, Christopher W. Hesse, CPA, for his leadership on the AICPA Tax Executive Committee!

Sources: AICPA Comments on REG-107213-18, Proposed Regulations Under Section 1061 dated November 23, 2020, Bloomberg Tax, RIA Checkpoint

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