Jobs Bill Reintroduces Provisions Increasing Tax on Carried Interest. On September 16, 2010, Senator Baucus introduced the "Job Creation and Tax Cuts Act," S. 3793 (the Bill). As with previous versions of this legislation, the Bill contains provisions substantially modifying the taxation of "carried interests" or investment services partnership interests (ISPIs).

For a detailed discussion of a prior bill that passed the House earlier in 2010 (the June Bill), please consult the Ropes & Gray Alert available here. Although the Senate took up the June Bill and proposed certain amendments to it, the June Bill ultimately never progressed through the Senate.

The key aspects of the current Bill include the following:

  • As in the June Bill, the Bill provides for a 75 / 50 recharacterization mechanic. In particular, 75 percent of income attributable to an ISPI would be recharacterized as ordinary income. An equal percentage of gain realized on most dispositions of an ISPI would be taxed as ordinary income. The amount treated as ordinary income is, however, reduced to 50 percent in the case of (a) any income that is attributable to the sale of any asset (other than an ISPI) which has been held by certain partnerships for at least 5 years and (b) any gain realized on the disposition of an ISPI held for at least 5 years and attributable to assets held by the investment partnerships for at least 5 years.
  • Consistent with the June Bill, income or gain with respect to certain "qualified capital interests" (QCIs) would not be recharacterized as ordinary income. However, ISPIs acquired with the proceeds of a loan obtained from certain affiliates could not qualify as QCIs. The Bill introduces a new provision that may permit partners to unwind such leveraged acquisitions of ISPIs in order that they may qualify as QCIs. Any such restructuring could not be achieved by repayment of the loan with the proceeds of a loan or other advance made by certain affiliates of the partner and such restructuring must be completed before the date of enactment of the Bill.

The Bill would generally be effective as of January 1, 2011. It is currently unclear whether the Bill will be enacted. The results of the November mid-term elections may dictate whether carried interest legislation in any form is enacted in the near future.

Managers of investment partnerships to which these rules may be applicable may want to consider restructurings that may in some cases ameliorate the impact of the new rules (e.g., restructuring in order to separate the holder of any ISPI from affiliated service providers such as management companies and unwinding any leveraged ISPI arrangements).

IRS Proposes Regulations on Domestic Series LLCs. On September 13th, the Internal Revenue Service (IRS) issued proposed regulations clarifying the federal tax treatment of an individual series of a domestic series limited liability company (and certain similar entities including domestic cell companies). The proposed regulations generally provide that each series of a domestic series entity, whether or not a juridical entity for state law purposes, is treated for federal income tax purposes as a separate entity formed under local law. Accordingly, the entity classification of such a series will be determined under generally applicable federal entity classification rules, including the "check-the-box" rules. Under the proposed regulations, each series and the umbrella series entity would be required to file a statement with the IRS for each taxable year providing certain identifying information to be specified in the future. The proposed regulations do not apply to series or to cell entities organized or established under the laws of a foreign jurisdiction, except when a foreign series or cell entity engages in an insurance business. Consequently the treatment of such foreign series and cell entities remains uncertain. The proposed regulations indicate that the new rules will generally be effective when finalized. A transition rule permits certain taxpayers to continue to treat a series and the umbrella series entity as one entity provided the series was established prior to September 13, 2010, no owner of the series treats the series as a separate entity, and certain other conditions are met.

IRS Circular 230 Notice

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained herein is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding U.S. tax penalties.