A recent First Circuit appellate court case has held for the first time that a private equity fund (a pair of funds, in fact) is a “trade or business” for purposes of ERISA multiemployer plan withdrawal liability. The direct implication for private equity funds, which you can read more about here, is that the funds may now be liable for the underfunded pension and multiemployer plan liabilities of their portfolio companies.

One of the indirect implications (and of relevance to this blog) is whether the “trade or business” rationale could be extended beyond ERISA to other areas of the Internal Revenue Code, and in particular to the areas governing the taxation of profits interests. Income allocated to management profits interests typically takes the character of the underlying income to the fund. If the fund is a passive investor, then the income to the fund typically passes through to the profits interest holder as capital gain. However if the fund is a “trade or business” and if the managers are actively engaged in that business, then income allocated to the managers’ profits interests may be taxed at higher ordinary income rates. While the First Circuit’s holding is limited to ERISA, the opinion casts a shadow on a pair of Tax Court precedents that practitioners have traditionally relied on for purposes of supporting the passive investor status of private equity funds in other tax-related contexts.

Profits interests remain safe for now, but in light of this new caselaw and Congress’s continuing interest in the subject, the question remains for how much longer.