United States: Tax Act: Key Issues For Pass-Through Entities, Including The Carried Interest

Last Updated: January 15 2018
Article by Robert D. Burke

Deduction for Qualified Business Income

General. The new Section 199A generally provides that for taxable years beginning after December 31, 2017, and before December 31, 2025, taxpayers other than corporations are entitled to deductions equal to 20% of their "qualified business income" for that year. The deduction is computed separately for each "qualified trade or business," although losses realized with respect to one qualified trade or business can effectively reduce the amount of the deduction available with respect to other qualified trades or businesses. The deduction is allowable in computing taxable income regardless of whether the taxpayer itemizes deductions.

Limitations. The amount of any deduction under Section 199A with respect to any qualified trade or business is subject to two limitations:

  • First, the aggregate amount of deductions for all qualified trades or businesses for a taxable year is generally limited to 20% of the taxpayer's taxable income (determined without regard to any deductions under Section 199A) other than (i) net capital gain and (ii) dividends that qualify for the reduced tax rate applicable to capital gains.
  • Second, the deduction with respect to each qualified trade or business cannot exceed the greater of (i) 50% of the W-2 wages paid by the qualified trade or business for the taxable year and (ii) the sum of 25% of such W-2 wages and 2.5% of the "unadjusted basis" (generally the cost) of depreciable property held and used in the trade or business during the year, provided that the period over which the property is depreciated (but no less than ten years) has not ended.

The second limitation does not apply if the taxable income of the taxpayer (determined without regard to any deductions under Section 199A) does not exceed a threshold amount initially established at $157,500 ($315,000 for married taxpayers filing jointly) subject to adjustment for inflation. For taxable income in excess of the threshold amount, the limitation is phased in over the next $50,000 ($100,000 for married taxpayers filing jointly). Thus, for example, if a single taxpayer's taxable income exceeded the threshold amount by $30,000, 60% of the excess of the 20% deduction over the limitation amount would be disallowed.

Qualified trade or business. The deduction is only available with respect to income from "qualified trades or businesses." Generally, a qualified trade or business is any trade or business other than "specified service businesses" and the performance of services as an employee. The specified service businesses include businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and related activities relating to securities, or "any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees." The exclusion of specified service businesses does not apply to taxpayers with taxable income less than the threshold amount described in the preceding paragraph. That exclusion is phased out over a $50,000 range ($100,000 for married taxpayers filing jointly) in excess of the threshold amount.

Qualified business income. Generally, the income that qualifies for the 20% deduction consists of income that is "effectively connected" to the conduct of a qualified trade or business.

  • The trade or business must be conducted within the United States;
  • Passive investment-type income is excluded; and
  • Compensation payments (including guaranteed payments made to partners) received by the taxpayer are excluded.

Application to partners and S corporation shareholders. Section 199A is applied at the partner or S corporation shareholder level with respect to the partner's or shareholder's allocable share of "qualified business income," W-2 wages and "unadjusted basis" of property of the partnership or S corporation, as applicable.

Special applications. Section 199A includes special provisions regarding the computation of the allowable deduction with respect to (i) dividends from REITs, (ii) income from publicly traded partnerships, and (iii) dividends from qualified cooperatives. In general, income from these sources qualifies for the 20% deduction without regard to the W-2 and "unadjusted basis" limitations.

Open questions. There are many unanswered questions regarding the potential application of Section 199A, including:

  • How is a "trade or business" determined? Can activities in separate entities be aggregated? Must they be aggregated?
  • How does one determine whether the principal asset of a trade or business is "the reputation or skill of one or more of its employees"? Consider how this provision would apply to chefs, masons, barbers, etc. Does this provision penalize highly successful businesses?
  • Can the amount of W-2 wages include payments to partners that are treated as "guaranteed payments" rather than "wages" solely because the recipient is a partner?
  • Should real estate businesses reorganize as REITs (dividends from which are not subject to the W-2 and "unadjusted basis" limitation and qualify for the 20% deduction regardless of the source of the REIT's income)?

Carried Interests

General. The Tax Act added a new Section 1061 to the Code effectively adopting a three-year holding period (rather than the normal one-year holding period) for long-term capital gain treatment for gain attributable to "applicable partnership interests," commonly referred to as "carried interests." The statute applies to both gain from the sale of applicable partnership interests held for three years or less and gain allocated to a partner with respect to an applicable partnership interest to the extent attributable to sales of assets held by the partnership for three years or less.

Applicable partnership interests. An "applicable partnership interest" generally is an interest in a partnership (including a limited liability company taxed as a partnership) transferred to the taxpayer in connection with the performance of substantial services by the taxpayer in an applicable trade or business. Exclusions exist for:

  • Interests held by corporations
  • Capital interests in partnerships (i.e., interests that allow their owners to participate in the economics of the partnership based upon the amount of capital the owner contributed or the amount of taxable income the owner realized upon the receipt or vesting of the partnership interest)

Applicable trade or business. An "applicable trade or business" is generally an activity that consists, in whole or in part, of (i) raising or returning capital from investors and (ii) investing in, disposing of, or developing, any of: securities, commodities, real estate held for rental or investment, cash, options or derivative contracts with respect to any of the foregoing types of assets, and interests in partnerships attributable to such assets (referred to as "specified assets"). The activity does not need to rise to the level of a "trade or business" as that term is used elsewhere in the Code.

Effective date. Section 1061 is effective for gain realized in taxable years beginning after December 31, 2017. There are no "grandfathering" rules for pre-existing partnership interests or assets held by pre-existing partnerships.

Open Questions. Section 1061 is relatively brief and leaves open many questions, including:

  • On a sale of an applicable partnership interest that has been held for more than three years, would Section 1061 apply to recharacterize gain economically attributable to assets held by the partnership for less than three years as short-term capital gain (since Section 1061, on its face, does not include a "look through" rule)?
  • If a partnership distributes assets in-kind in redemption of some or all of an applicable partnership interest, would gain from the sale of the distributed asset be subject to the three-year holding period requirement if the partnership interest had not been held for more than three years, or if the distributed asset had not been held for more than three years, or if other assets of the partnership had not been held for more than three years?
  • Although rental real estate is included in the definition of "applicable trade or business," a technical reading of the statute leads to the conclusion that it does not apply to gain attributable to depreciable assets or real property used in a trade or business. Is a technical correction to the statute necessary to correct this seeming oversight?
  • Section 1061 only applies with respect to net long-term capital gain "if one or more applicable partnership interests are held by a taxpayer at any time during the taxable year." If an applicable partnership interest is sold for an installment note, is the gain realized in a subsequent year immune from recharacterization under this provision? Would it matter that the taxpayer owned an applicable partnership interest in another partnership at the time the installment payment was received?
  • Section 1061(b) provides that "to the extent provided by the Secretary," the general rule of Section 1061 shall not apply to gain "attributable to any asset not held for portfolio investment on behalf of third-party investors." Will this exception be available prior to the promulgation of regulations (or similar) by the IRS?
  • If investors lend the service provider the amount necessary to buy a "capital interest" that has the same share of profits as the carried interest would have had, does Section 1061 apply? Does it matter whether the loan is recourse or nonrecourse (secured by the purchased interest)?

Limitation on Business Losses

The new Section 461(l) limits the ability of taxpayers other than corporations to use losses attributable to trades or businesses to offset more than $250,000 ($500,000 for joint returns) of non-trade or business income. The $250,000 ($500,000) amount is subject to adjustment for inflation. The limitation is applied after application of the passive loss rules, and any loss disallowed under Section 461(l) is carried over to the following year and treated as a net operating loss carryover (which, as a result of the Tax Act, can now only offset 80% of taxable income). For taxpayers who are partners in partnerships or shareholders of S corporations, the limitation is determined at the partner or shareholder level, as applicable. Section 461(l) is effective for taxable years beginning after December 31, 2017, and before January 1, 2026.

Repeal of Technical Terminations of Partnerships

The Tax Act repealed Section 708(b)(1)(B) of the Code, which previously provided that a partnership would be considered to have terminated for federal income tax purposes if there was a sale or exchange of 50% or more of the total interests in partnership capital and profits. Such a technical termination of the partnership generally created two short taxable years, terminated all of the partnership's tax elections, required the partnership to restart depreciation periods and could change the holding period that the partners had for their interests in the partnership. Although elimination of the provision will allow taxpayers to avoid the administrative and substantive tax costs associated with a termination, it will also eliminate a tax-planning tool that could be employed to eliminate tax elections, change accounting methods and rectify missed elections under Section 754 of the Code.

Read more commentary from WilmerHale lawyers on the Tax Act.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
McLane Middleton, Professional Association
Hunton Andrews Kurth LLP
Archer & Greiner P.C.
Proskauer Rose LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
McLane Middleton, Professional Association
Hunton Andrews Kurth LLP
Archer & Greiner P.C.
Proskauer Rose LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions