Client Alerts

Carried Interest Taxation – IRS Issues Notice 2018-18 Stating it Intends to Issue Regulations that “Corporation” does not include an S Corporation

Client Alerts | March 1, 2018 | Emerging Companies & Venture Capital | Hedge Funds

On March 1, 2018, Notice 2018-18 was released, announcing that the Department of the Treasury and the Internal Revenue Service (the “IRS”) intend to issue regulations providing guidance on the application of Section 1061 of the Internal Revenue Code, which relates to the taxation of carried interest. The Notice further announced that the regulations will provide that, for purposes of the exception to the new carried interest rules, the term “corporation” does not include an S corporation. The regulations addressing the meaning of “corporation” would be effective for taxable years beginning after December 31, 2017.

As noted in our prior alert “Carried Interest Planning Under the New Tax Legislation,” the statutory language provides that the new changes (which generally require a three-year holding period for long term capital gains with respect to a carried interest) do not apply to carried interests held directly or indirectly by “corporations.” Corporations for this purpose would include C corporations (both domestic and foreign) and S corporations. Some have considered checking the box to have their existing GP taxed as an S corporation (or C corporation) effective January 1, 2018. Some have considered setting up limited liability companies to own the interests in the GP and making S corporation elections for the LLCs. In either of these scenarios, there is some degree of retroactivity since a check the box election to tax the LLC as a C corporation or S corporation can be made retroactively to January 1, 2018, if such election is made on or before March 15, 2018.

The S corporation issue has received a lot of press in response to a recent article published by Bloomberg. The IRS seemingly issued the Notice now due to the upcoming March 15th deadline.

It is not entirely clear whether the IRS has the authority to issue regulations providing that the term “corporation” does not include an S corporation. Nonetheless, Notice 2018-18 is likely to have a chilling effect on the S corporation planning discussed above.

If you have any questions on how to proceed with your carried interest planning in light of Notice 2018-18, or any other tax questions regarding the new tax legislation or otherwise, please contact your primary Kleinberg Kaplan attorney or any attorney listed above.