One Big Beautiful Bill Act

On July 4, 2025, President Trump signed the One Big Beautiful Bill Act ("OBBBA") into law. Several provision in the OBBA have tax implications for private fund sponsors and their investors. Notably, a number of potential provisions that could have been included in the bill that would have been very harmful to private funds or their investors ultimately were excluded. We highlight the key domestic and international tax changes that are relevant to private fund sponsors and their investors, as well as some of the proposals that did not make it into the final version of the bill.

In the initial months since the enactment of the OBBBA the funds industry has begun to respond to new legislation. Many funds have already updated their private placement memoranda ("PPMs") to address the tax changes included in the OBBBA. Certain provisions of the OBBBA have prompted other reactions, as discussed below.

Domestic Provisions

SALT Deduction Changes

For taxable years beginning after December 31, 2024, the cap on the deduction for state and local income taxes ("SALT") for individuals is temporarily increased from $10,000 to $40,000 through 2029. However, this increased cap is phased out for taxpayers with modified adjusted taxable gross income over $500,000.

Certain states allow pass-through entities to elect to pay state income taxes at the entity level on behalf of their individual owners ("Pass-Through Entity Tax Elections"). Because businesses are not subject to the federal SALT deduction cap, such an election effectively allows the owners of the pass-through entity to receive a full deduction on their federal income tax return for the state taxes paid by the pass-through entity, notwithstanding the SALT deduction limitations applicable to individuals described above.

While the OBBBA did not eliminate the viability of Pass-Through Entity Tax Elections, earlier versions of the bill would have eliminated this workaround. Fund sponsors and investors who benefit from Pass-Through Entity Tax Elections should be aware that they may be eliminated in future tax legislation.

Carried Interest

There have been multiple bills proposed in Congress over the past several years to repeal the tax advantages of carried interest. President Trump has repeatedly indicated his support for such a repeal. Surprisingly, however, no such provision was included in any version of the OBBBA. Nevertheless, Section 1061,¹ which was enacted as part of the Tax Cuts and Jobs Act of 2017 (the "TCJA") and which generally imposes a three-year holding period in order for a carried interest owned by a fund manager to eligible for favorable capital gains treatment when fund assets are sold, still applies.

Although fund managers can continue to benefit from the tax advantages associated with carried interest for now, fund managers should be alert to possible changes in the taxation of carried interest in future legislation.

Changes to Interest Deduction Limitation Under Section 163(j)

The TCJA amended Section 163(j) to impose a limitation on the amount of net business interest expense that may be deducted by a taxpayer. The deduction for net business interest expense is limited to 30% of adjusted taxable income ("ATI"). The TCJA originally required ATI to be calculated as earnings before interest, taxes, depreciation, and amortization ("EBITDA"). However, for years beginning after December 31, 2021, ATI was calculated as earnings after taking into account depreciation and amortization deductions (approximating EBIT), which further limited taxpayers' ability to deduct business interest. The OBBBA restored the original ATI calculation, which is a more taxpayer-favorable calculation, for 2025 and all future tax years.²

While that is a positive change for taxpayers, including funds or investors that utilize leveraged blocker structures, the OBBBA now excludes Subpart F income and NCTI inclusions from controlled foreign corporations (discussed below) and Section 78 gross-up amounts from the definition of ATI for tax years beginning after December 31, 2025. The OBBBA also requires that most capitalized interest be taken into account when applying the limitation. The 163(j) limitation amount must first be applied to capitalized interest, thereby reducing the portion of the limitation that is available for deductible interest.

Overall, the changes to Section 163(j) are beneficial for funds, portfolio companies and management companies, especially for heavily leveraged portfolio companies and leveraged blockers, as the new rules generally allow for greater interest deductions, lowering the after-tax cost of borrowing. Investments that are leveraged and that benefit from depreciation or amortization (e.g., as a result of a stepped-up basis resulting from an acquisition) may now be more attractive from a tax perspective. However, investments that involve controlled foreign corporations may be less attractive.

Fund sponsors may be inclined to increase fund leverage in light of the expanded deductibility of interest expense; however, we have not yet seen evidence of that.

199A Deduction

Under Section 199A, introduced as part of the TCJA, certain noncorporate taxpayers enjoy a deduction for up to 20% of qualified business income derived from certain trades or businesses. This 20% deduction would have expired at the end of 2025, but the OBBBA makes the deduction permanent.

The permanent extension of Section 199A allows private funds with pass-through structures to build tax strategies around this benefit. Also, private funds that invest in pass-through operating businesses can provide tax benefits to qualifying investors who participate in such investments on a pass-through basis.

This may be a great time to revisit tax structures and other planning strategies to fully utilize this deduction.

Permanent extension of Section 199A is also good news for funds that include real estate investment trusts ("REITs") in their structures because qualified REIT dividends are also eligible for the Section 199A deduction. There may be an opportunity for funds that use REITs to remind potential individual investors of this permanent tax benefit, as it provides an additional incentive to invest in funds that use REITs. The favorable treatment of qualified REIT dividends is one factor that real estate funds may consider when evaluating whether to utilize a REIT structure and whether to capitalize a REIT with shareholder loans in addition to equity.

Qualified Opportunity Funds

The qualified opportunity zone ("QOZ") provisions were scheduled to expire at the end of 2025 but instead have been made permanent by the OBBBA, with some revisions. State governors will now propose new QOZs every 10 years with the first new designations starting on July 1, 2026, which will go into effect on January 1, 2027.

Under the OBBBA, taxpayers may benefit from the new rules that apply to qualified opportunity funds ("QOFs"), which invest in QOZs, starting January 1, 2027.Investors can defer capital gains that are invested in QOFs until the disposition of their investment or five years from the date of investment, whichever is earlier. In addition, after holding the investment for five years, an investor in a QOF obtains a 10% step-up in basis (the additional 5% basis step-up after seven years that was available under the prior rules has been eliminated under the OBBBA). The step-up will be increased to 30% for property in a qualified rural opportunity zone ("QROZ"). Furthermore, taxpayers are able to exclude gains upon sale of QOF investments that are held for at least 10 years (including gain that would otherwise be recognized as depreciation recapture).

These changes are favorable for investors and sponsors with respect to QOZ projects after 2026.These changes can also create opportunities in combinations with other tax mitigation strategies such as loss harvesting, charitable remainder trusts, or bonus depreciation strategies. Notably absent from the final legislation was any further expansion of the QOZ fund structuring options available to sponsors and investors. Specifically, QOFs still may not invest in other QOFs, effectively prohibiting the organization of "fund of fund" QOFs. Consequently, it appears that the popular two-tier strategy—involving one or more QOFs investing through one or more qualified opportunity zone businesses—is likely to prevail going forward.

TRS Increase

REITs are limited in the types of assets they may hold, the types of income they may generate, and the services they may provide to their tenants. A taxable REIT subsidiary (a "TRS") is a taxable corporation that is permitted to engage in activities that its parent REIT cannot. However, there is a cap on the percentage of a REIT's assets that may consist of securities of a TRS. The OBBBA increased that percentage cap from 20% to 25% for tax years beginning after December 31, 2025. For funds with REITs that are close to the current 20% limitation, this is a welcome change and provides greater planning flexibility.

Excise Tax on Private Universities

The excise tax on private universities with large endowments was modified by the OBBBA. For taxable years beginning after December 31, 2025, the excise tax will apply only to institutions that have at least 3,000 tuition-paying students, more than 50% of which are located in the United States, and only if the value of the institution's endowment is at least equal to $500,000 per student. In addition, for taxable years beginning after December 31, 2025, the 1.4% excise tax rate will increase to 4% if the value of the institution's endowment is greater than $750,000 per student, and will increase to 8% if the value of the institution's endowment is greater than $2,000,000 per student. For purposes of these calculations, international students are subtracted from the denominator used to calculate the endowment per student, potentially pushing more institutions over the threshold for the excise tax to apply.

Energy Credits

While the OBBBA preserves the availability of certain clean energy incentives, it also accelerates the phaseouts of others, including tax credits for wind, solar, and electric vehicles. For a more detailed discussion of the renewable energy tax changes under the OBBBA and their impact on renewable energy developers, tax equity investors, tax credit purchasers, lenders, and manufacturers, please refer to our prior client alert on this topic.³ Private funds investing in renewable energy are evaluating the timelines of their projects in light of the changes.

International Provisions

Changes to CFC Rules

The OBBBA has restored Section 958(b)(4), which, prior to its repeal by the TCJA, prevented the downward attribution of stock ownership from a related foreign person to a U.S. person for purposes of determining whether a foreign corporation is a "controlled foreign corporation" ("CFC") and whether a U.S. person is a "U.S. shareholder" (i.e., owns 10% or more of the CFC's equity by vote or value). A CFC is any non-U.S. corporation if more than 50% of either the total value of the corporation's stock or the total combined voting power of all classes of the corporation's stock entitled to vote is owned (or is considered owned) by U.S. shareholders on any day during the taxable year of such non-U.S. corporation. The TCJA repealed Section 958(b)(4) to prevent an inverted U.S. company from "de-controlling" its CFC subsidiaries. However, the repeal of Section 958(b)(4) resulted in many foreign corporations unexpectedly becoming CFCs in scenarios unrelated to this policy concern. As a result of the restoration of Section 958(b)(4), it is less likely that foreign corporations with predominantly non-U.S. shareholders will be classified as CFCs. One common CFC trap arising after the repeal of Section 958(b)(4) under the TCJA involved U.S. subsidiary corporations being deemed to own interests in brother-sister entities through application of the downward attribution rules. This development may alleviate certain U.S. tax and information reporting obligations for private funds, particularly those utilizing offshore holding companies.

This change is particularly meaningful for funds and co-investment vehicles that utilize leveraged blockers with significant foreign investors. For many non-U.S. investors, interest income received from shareholder loans to a leveraged blocker is subject to 30% U.S. withholding tax unless the interest qualifies for the "portfolio interest exemption."Among other limitations, the portfolio interest exemption does not apply if the beneficial owner of the interest is a CFC that is related person with respect to the borrower (generally requiring a 50% affiliation by vote or value with the borrower). As a result of Section 958(b)(4) repeal, many foreign entities that had no direct or indirect U.S. ownership became CFCs and, if there was sufficiently concentrated ownership of the U.S. borrower, were rendered ineligible for the portfolio interest exemption as a result. The reinstatement of Section 958(b)(4) is a welcome development for many non-U.S. investors, particularly in the context of a fund of one or a co-investment vehicle where ownership stakes are typically larger. We note, however, that because the OBBBA authorizes the Secretary of the Treasury to issue regulations with respect to treating a newly defined "foreign controlled foreign corporation" as a CFC for portfolio interest purposes, future Treasury Regulations could undo the benefit of Section 958(b)(4) for many non-U.S. investors hoping to claim the portfolio interest exemption.

Certain funds with investors that had been subject to the CFC exclusion as a result of the downward attribution rules are considering restructuring to implement shareholder loan structures to allow such investors to take advantage of the portfolio interest exemption. In addition, fund sponsors should review whether the portfolio interest exemption is now available for non-U.S. investors in existing leveraged blocker structures.

The OBBBA also modifies the rules that determine the amount of Subpart F income or Net CFC Tested Income ("NCTI") (formerly global intangible low-taxed income or GILTI) that a U.S. shareholder must include with respect to a CFC. Under prior law, a U.S. shareholder included its pro rata share of Subpart F income and GILTI only to the extent it held stock of the foreign corporation on the last day of the year on which such foreign corporation was a CFC.⁴ Under the OBBBA, a U.S. shareholder that owns stock of a CFC at any time during the tax year may have a Subpart F or NCTI inclusion with respect to such CFC even if the shareholder does not own such stock on the last day of the year. The pro rata share of the U.S. shareholder is the portion of the CFC's income that is attributable to the stock of the CFC directly or indirectly owned by such U.S. shareholder and any period of the CFC year during which such shareholder owned such stock.This makes it more likely for U.S. investors to get tripped up in the punitive CFC tax regime, and it will now become more important than ever to ensure that private funds are performing due diligence in regards to their offshore investments. U.S. investors that own a significant percentage of interests in a fund are continuing to request that funds implement procedures to evaluate whether a portfolio investment or non-U.S. fund entity is a CFC and provide appropriate information to investors to enable U.S. shareholders to comply with information reporting requirements.

Section 899

As we previously reported, earlier versions of the bill that became the OBBBA included what would have been a new Section 899 that imposes retaliatory tax measures against residents of countries that imposed a Pillar Two undertaxed profits rule (the "UTPR"), a digital service tax (a "DST") or certain other putatively discriminatory or unfair taxes on U.S. taxpayers.

On June 28, 2025, the G7 released a statement announcing an agreement that U.S. parented groups would be exempt from the Pillar Two income inclusion rule (the "IIR") and UTPR, in recognition of the existing GILTI and corporate alternative minimum tax rules in the Internal Revenue Code. The G7 statement provides that these U.S. minimum tax rules and Pillar Two can work on a "side-by-side" basis, such that U.S.-parented groups would be exempt from a country's UTPR and IIR. As a result of this agreement with the G7, proposed Section 899 was removed from the bill and no retaliatory tax measures were included in the OBBBA.

Statutory changes may be required in many countries in order to implement this agreement and to exempt U.S. groups from the IIR and the UTPR. The European Union (the "EU") has indicated that EU member states may implement this agreement using existing safe harbor provisions. In addition, the implementation of this "side-by-side" approach raises a number of questions that would need to be clarified (e.g., treatment of U.S. subsidiaries of non-U.S. groups, including non-U.S.––U.S.––non-U.S. "sandwich" structures).

It is also worth noting that the G7 announcement does not address the DSTs implemented by many countries. Based on precedent from the first Trump administration, it is possible that the U.S. Trade Representative may pursue trade investigations against foreign countries that impose DSTs on U.S. companies so as to impose U.S. tariffs or other sanctions if it is found that the DSTs constitute unfair trade practices.

Section 899 as it was proposed could have significantly adversely affected non-U.S. fund investors resident in countries with tax regimes that were perceived to be "discriminatory" by significantly increasing income and withholding tax rates for such investors on U.S.-source income. Also, certain treaty structures for funds would have been compromised by Section 899.Although Section 899 was not enacted, the prospect of it being reintroduced in the future in lights of its "success" as a negotiating tactic, particularly if the implementation process of the G7 agreement hits roadblocks, has caused non-U.S. investors to express reservations about making investments in the U.S., particularly when combined with tariffs and sanctions being implemented by the administration.

Expat Exclusion

Multiple bills have been introduced over the years that would end the citizenship-based taxation of U.S. citizens and shift to a residency-based system of taxation. While the OBBBA did not address this issue, President Trump promised during his 2024 campaign to implement such a change.

Such a change should only benefit U.S. taxpayers, and if there is movement in this regard it may be prudent for U.S. citizens to begin contemplating how to potentially take advantage of such a change in taxation.

No Vote / Value Fix for Portfolio Interest Exemption

In order to qualify for the portfolio interest exemption, a non-U.S. investor may not own 10% or more of the combined voting power of all classes of voting stock of the issuer (or 10% or more of the capital or profits interest if the issuer is a partnership). In order to avoid the loss of the portfolio interest exemption for non-U.S. investors that own more than 10% of the value of a leveraged corporate blocker, many fund sponsors hold 100% of the voting equity, while non-U.S. investors hold non-voting equity in the blocker. Prior proposed tax legislation included a provision to change this rule so that the portfolio interest exemption would not be available to non-U.S. investors that own 10% or more of either the voting power or the value of an issuer. No language addressing such efforts was included in any of the draft versions of the OBBBA. Nevertheless, if such rule changes were implemented, they could severely affect the after-tax returns for non-U.S. fund investors that are reliant on the portfolio interest exemption.

No Lowering of Tax Rate for Corporations

President Trump has publicly discussed the possibility of lowering the corporate tax rate from the current 21% rate. No language addressing this idea was included in any of the draft versions of the OBBBA. It is unclear at this time if an effort to lower the corporate tax rate will take shape, but if such a law were to be passed, the tax leakage of many fund structures utilizing corporate blockers could be reduced.

Footnotes

1 References to "Section" herein refer to sections of the Internal Revenue Code of 1986, as amended.

2 Please also refer to our previous client alert on this change: link

3 House Reconciliation Bill Amends Clean Energy Provisions of the IRA: link; United States Senate Finance Committee Makes Changes to Clean Energy Provisions of the Proposed One Big Beautiful Bill: link; House Enacts the Senate Legislative Text of the One Big Beautiful Bill Act: link.

4 Please also refer to our previous client alert on this change: link

Originally published by The Hedge Fund Journal

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