Final Treasury Regulations Issued Addressing the Application of Section 1061 to Carried Interests

On Jan. 8, 2021, the Department of the Treasury (Treasury) and the Internal Revenue Service (the Service) issued final regulations (Final Regulations) (T.D. 9945) governing the treatment of “carried interests” (also referred to as “profits interests”) under Section 1061 of the Internal Revenue Code. Enacted under the Tax Cuts and Jobs Act, Section 1061 generally limits the availability of long-term capital gain treatment with respect to gain attributable to profits interests held for less than three years by managers of private equity, hedge and real estate funds. The Final Regulations adopt with some revisions the Proposed Regulations issued on July 31, 2020. For a detailed discussion of the proposed regulations, please see our Tax alert here.

Notable differences between the Final Regulations and the Proposed Regulations include:

• Simplified rules with respect to distinguishing between bona fide “capital interests” and profit interests subject to Section 1061
• More taxpayer-favorable rules with respect to debt-financed capital contributions
• Simplified “look-through” and indirect ownership rules
• Clarified rules with respect to related party transfers

While the changes made in the Final Regulations are taxpayer friendly in many respects, the Final Regulations reaffirm Treasury’s extension of Section 1061 to carried interests held by S corporations, notwithstanding explicit statutory language that exempts interests held by corporations from application of the rules. 

The Service continues to study and solicit comments on many areas, and additional guidance under Section 1061 may be issued in the future.

Subject to certain exceptions, the Final Regulations apply to tax years beginning on or after the date Final Regulations are published in the Federal Register.

A more detailed Kramer Levin Tax alert is forthcoming.