Post Year-End Tax Issues and Planning to Consider
This tax alert briefly highlights certain tax issues and planning that hedge and private equity fund managers and high-net-worth individuals should consider (or reconsider) now that we are in the new year. Our 2021 year-end tax alert highlighted many items to consider and potential tax moves to take before year-end and highlighted proposed tax changes. It is still not clear when or if any tax legislation will be enacted.
Some of the year-end planning ideas discussed in our alert are still relevant today, including carried interest planning, under the now effective final regulations, and making or revoking elections under Section 475(f) of the Internal Revenue Code.
Post Year-End Tax Planning
1. Changing state tax residency. Due to the effectiveness of remote working, some people have considered changing (or have changed) their residency, including to low–tax jurisdictions. But beware of traps like the “convenience of the employer” rule and the possibility that a move results in double state taxation.
2. Moving to Puerto Rico or the USVI. Puerto Rico and the USVI offer U.S. citizens the potential ability to significantly reduce their federal taxes without giving up their U.S. citizenship. Becoming a bona fide resident of Puerto Rico or the USVI can offer significant tax advantages. There are, however, many tax and non-tax issues to consider.
3. State and local tax-free trusts. Trusts can offer significant income and estate tax planning opportunities. One potential benefit is avoiding the imposition of state and local taxes on trust income.
4. Private Placement Life Insurance (“PPLI”) / Insurance Dedicated Funds (“IDFs”). PPLI and IDFs may offer the opportunity to reduce income and estate taxes and, conversely, a way for fund managers to increase assets under management.
5. Revisit use of C Corporations. With individual tax rates potentially increasing and corporate tax rates staying the same, it may be time to revisit the use of C corporations instead of sole proprietorships or pass-through entities for business operations.
6. Plan for Pass-Through Entity Taxes (“PTET”). A number of states have enacted pass-through entity taxes as a workaround of the $10,000 federal limit on the deductibility of state and local taxes. For example, New York State’s PTET was enacted in April 2021. For 2022, the NYS PTET has to be elected into by March 15, 2022. The NYS PTET (and other pass-through entity taxes) should be considered for 2022. Do you need to change to a partnership from a sole proprietorship? Do you need to create a sleeve for partners subject to NYS tax? Is there any additional guidance on the application of the PTET to a partnership or S corporation that is considered to be an investor for tax purposes (as opposed to a trader or dealer)? Do the New York State PTET forms (when they are issued) provide any guidance or raise any issues?
7. Passive Foreign Investment Companies (“PFICs”). PFICs may offer a way to reduce or defer federal taxes (at a low interest rate) and may offer a way to reduce or defer state and local taxes as well.
8. Opportunity Zones. Investing in opportunity zones offer a way to defer taxes or eliminate taxes (on subsequent appreciation). The ability to increase basis if investments were made prior to 2022 (10% if made prior to 2022 and an additional 5% if made prior to 2019). The opportunity zone rules may be subject to change, and deferral may not be a good play if rates are increasing over time.
9. Excess Business Loss (“EBL”) Rules. The impact of the EBL rules to fund managers should be considered, particularly if funds managed are considered to be investors, and not traders, for tax purposes. For example, a fund manager of an investor fund should consider the application of the EBL rules to the investment manager and the general partner. The EBL limitation rules would be subject to significant changes under the proposed tax changes. Currently, the EBL rules apply through 2026. As proposed, the EBL rules would not expire. And a potentially more important change is that carryovers of EBLs would no longer be converted to net operating losses, but would remain EBLs and subject to the EBL rules.
10. Estate and Gift Taxes. The tax proposals do not include any of the previously proposed estate and gift tax changes. Click here for our prior client alerts on estate and gift tax proposals. Nevertheless, with the current unified credit amount (the amount that a person can give gift-tax and estate-tax free) expiring at the end of 2025) and the continued focus on the taxation of wealthy individuals, it might be useful to plan to use your unified credit amount (currently about $12 million per person or $24 million per married couple) before it is decreased or other estate and gift tax changes are made.
If you have any questions regarding this client alert, please contact your primary Kleinberg Kaplan attorney or a member of our Tax Department listed to the right.