Tax Issues and Planning to Consider Before and After Year-End 2025

This newsletter briefly highlights certain tax issues and planning opportunities that fund managers and high-net-worth individuals should consider (or reconsider) before and shortly after the end of 2025.

While the One Big Beautiful Bill Act (the “OBBBA”), signed into law earlier this year, included many changes to the tax system, the final bill had far less impact on funds and fund managers than initial proposals had indicated it might. Among other changes, the OBBBA made permanent many provisions of the 2017 Tax Cuts and Jobs Act that were otherwise scheduled to sunset, and included marginal changes to certain existing rules. Notably, the OBBBA did not increase individual or corporate tax rates, change the taxation of carried interest and incentive allocations, or eliminate the use of pass-through entity taxes to mitigate the limitation on the deductibility of state and local taxes. As a result, many of the tax planning strategies utilized by fund sponsors and high-net-worth individuals in recent years remain applicable.

YEAR-END TAX PLANNING

1. Review your fund’s 2025 tax picture. Year-end presents an opportunity to take stock of your fund’s tax picture. Ask yourself key questions in making this evaluation. For example:

• How does your fund’s taxable income compare to its book income? Some managers prefer to keep taxable income below book income, to defer investors’ current tax burden without impacting reported performance. Others prefer taxable income and book income to match as closely as possible, to improve alignment between reported performance and investor tax consequences.
• Do you have any unrealized gains that you should realize in 2025? Alternatively, do you have unrealized gains that will become “long-term” if you hold off on selling the asset until 2026? Perhaps you have unrealized losses that you should realize in 2025, including before they become long-term? As you evaluate these points, keep in mind the wash sale rules (discussed below) and straddle rules.

2. Accelerate income or losses into 2025. Consider whether to accelerate the realization of taxable gains in 2025 that you otherwise might not have recognized until 2026 or later, if you want to increase your 2025 taxable income. In contrast with losses, there are no “wash sale” rules for gains, meaning you can sell something at a gain and buy it back soon after without any suspension of the gain. Following passage of the OBBBA, it is unlikely that tax rates for 2026 will be lower than those for 2025.

3. Accelerate expenses to 2025. If there are tax-deductible expenses you were otherwise planning to incur in 2026, consider incurring them in 2025 to decrease 2025 taxable income. This could be beneficial if you anticipate that the applicable tax rates will be lower in 2026 (i.e., if you expect your income will be taxed at a lower rate in 2026 than in 2025).

4. Pay state and local taxes in 2026. The OBBBA temporarily increased the limitation on the deductibility of state and local taxes from $10,000 to $40,000, subject to an income-based phase out up to modified adjusted gross income of $600,000 – the limitation for taxpayers with income at or above that threshold will continue to be $10,000.Accordingly, delaying payment of such taxes until 2026 is not expected to result in any additional deduction. However, for taxpayers who did not make a timely pass-through entity tax election for 2025, it may be possible to delay income until 2026 so that state and local taxes may be paid by an entity, rather than personally, or by an entity for which a timely pass-through entity tax election has not been made in 2025 but will be made for 2026, so that the taxes are effectively deductible in 2026 rather than being non-deductible in 2025. (See “Pass-Through Entity Taxes” below.)

5. Pay bonuses in 2025. A manager using the cash basis method of accounting for tax purposes may reduce its 2025 taxable income by paying bonuses in 2025. A manager using the accrual method of accounting must pay 2025 bonuses no later than March 15, 2026, to deduct the bonuses in 2025, assuming the other accrual requirements are met.

6. Wash sales. The recognition of a loss in 2025 could potentially be retroactively undone by entering into a wash sale within 30 days. Accordingly, one could take the loss in 2025 as originally planned or undo the loss by repurchasing the position. The wash sale rules offer some degree of flexibility regarding the timing of losses and possibly the character of losses, such as converting long-term capital losses to short-term capital losses. You may also use basket swaps to restore economic exposure to the loss position without triggering suspension of the loss under the wash sale rules. A basket swap that reflects at least 20 stocks and does not have 70% or more overlap with the position that was sold at a loss will generally not trigger a suspension of the loss.

7. Constructive sales. The constructive sale rules also offer flexibility regarding timing of income, but with respect to gains instead of losses. For example, you could enter into a position that is a constructive sale (e.g., shorting an appreciated stock position) and either:

• terminate the constructive sale (e.g., the short sale) by January 30, 2026, and leave the appreciated position unhedged for 60 days thereafter, in which case there would not be a constructive sale in 2025; or
• not terminate the constructive sale by January 30, 2026, or not leave the position unhedged for 60 days thereafter, in which case there would be a constructive sale in 2025.

This effectively provides flexibility, until March 30, 2026, to make a retroactive decision about whether the gain is triggered in 2025.

8. Section 475(f) election. A Section 475(f) election to mark-to-market securities can offer significant tax benefits for a trader in securities. For example, if you are a trader and have significant net unrealized losses, you could wait until 2026 to realize the losses and make an election to mark-to-market for 2026, thus converting capital losses to ordinary losses (which may be applied against ordinary income in 2026 without limitation). Alternatively, if you have unrealized gains, you could wait until 2026 to realize the gains and make an election to mark-to-market in 2026 and prorate the recognition of gain over a four-year period. This would, however, also convert capital gains to ordinary income. In contrast, if your fund already has a Section 475(f) election in place, you should consider whether it still makes sense to maintain in light of your current circumstances or should be revoked if permissible.

TAX PLANNING AFTER YEAR-END

The following are some tax planning ideas that may help reduce your effective tax rate going forward.

1. State tax residency. Due to the effectiveness of remote working, some have considered changing (or have changed) their residency, including to low-tax (or no-tax) jurisdictions. Anyone considering such a change should beware of traps like the “convenience of the employer” rule and the possibility that a move will result in double state taxation because of limitations on or unavailability of credits. Note also that a person is still subject to tax in other states on income sourced to such states.

2. Puerto Rico and the USVI. Puerto Rico and the USVI offer U.S. citizens the potential to significantly reduce their federal tax rate without giving up their U.S. citizenship. There are a number of rules and requirements that must be met, but the tax savings can be considerable.

3. State and local tax-free trusts. Trusts can offer significant tax planning opportunities. One potential benefit is avoiding the imposition of state and local taxes on trust income. However, federal income tax brackets are more compressed for trusts, so care should be taken to ensure that the state-level tax benefit outweighs any additional federal income tax cost.

4. Private Placement Life Insurance (“PPLI”) / Insurance Dedicated Funds (“IDFs”). PPLI may offer the opportunity to reduce income and estate taxes, including by providing the ability to hold tax-inefficient assets within a tax-advantaged insurance “wrapper” and, generally, by keeping the policy outside the taxable estate. IDFs may offer managers a way to increase assets under management.

5. Pass-Through Entity Taxes (“PTET”). Many states have enacted pass-through entity taxes as a workaround to the $10,000 limit (now $40,000 but phased out as discussed above) on the deductibility of state and local taxes (“SALT”) for federal income tax purposes. For example, New York State and New York City have enacted pass-through entity taxes. NYS and NYC PTET elections must be made by March 15^th of the applicable year (e.g., for 2026, by March 15, 2026), though other jurisdictions may have different election deadlines. While the OBBBA included some changes to the SALT deduction limitation, it did not include any restriction on these state-level PTET workarounds.

While PTET regimes can provide material tax benefits, each state’s PTET has its own nuances, and there are potential pitfalls and important considerations for each such regime. Common questions include:

• Do you need to admit a new member to your LLC so it is treated as a partnership rather than a sole proprietorship to take advantage of the PTET?
• Do you need to create a separate sleeve for partners subject to NYS tax?
• Do you need to create a separate partnership for certain investments?
• Should very highly compensated employees be made partners or indirect partners of management companies to benefit from the PTET rules?

6. Opportunity Zones. Investing in opportunity zones offers a way to defer taxes or eliminate taxes (on subsequent appreciation). The OBBBA made the opportunity zone regime permanent and overhauled some of the mechanics to tighten the targeting of specific zones, change gain deferral timing, and add more robust reporting. These rules still offer considerable tax benefits.

7. Excess Business Loss (“EBL”) Rules. The OBBBA made the EBL rules permanent. The impact of the EBL rules on managers should be considered, particularly if the funds under management are considered to be investor funds, rather than trader funds, for tax purposes. For example, a fund manager of an investor fund generally would not be able to increase its loss deduction threshold under the EBL rules for incentive allocation income from the fund because it would not be considered “trade or business” income.

8. Incentive Fee Versus Allocation. In the wake of the Soroban case and other similar cases regarding whether a limited partner’s distributive share of fee income earned by a management company which was formed as a limited partnership is subject to self-employment tax, managers currently taking an incentive fee instead of an incentive allocation may wish to consider their effective tax rate if those fees become subject to self-employment tax. Most are not yet changing structures until and unless case law becomes more definitive or legislation or other guidance is enacted or promulgated.

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If you have any questions regarding the above or any other tax issues, please contact your primary Kleinberg Kaplan attorney or a member of our Tax Practice.