Blog Posts Tagged With Pass-Through Entities

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Comparison of the Final House and Senate Bills

While the last-minute changes made to the Senate Bill brought the House and Senate Bills closer together, a number of important differences remain.  The House and Senate will attempt to hammer out these differences over the next few weeks in conference committee. In the meantime, we have prepared a comparison of the more salient provisions of the two bills.

You can view the full text of the bills on our House Bill Navigator and Senate Bill Navigator. We also ran a comparison of the final Senate Bill against the initial legislative text, which is available here.
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Chairman Hatch’s Modifications at a Glance

Last night the Joint Committee on Taxation released a description of Senate Finance Committee Chairman Hatch’s proposed Modifications to the Senate Mark of the Tax Cuts and Jobs Act.  Reports in anticipation of the Chairman’s Modifications had described them as intended to reduce the deficit increases otherwise expected under the initial Senate Mark.  The JCT also released an updated score last night that reflects the impact of the Chairman’s Modification. In addition to modifying the tax brackets applicable to individuals, increasing the child tax credit, and repealing the individual mandate to obtain health insurance under the Affordable Care Act, the Modification make several noteworthy revisions to the original Chairman’s Mark.
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Comparing the House and Senate Tax Proposals Affecting Private Equity

The House and Senate versions of the Tax Cuts and Jobs Act would each have a significant impact on private equity firms, investors and portfolio companies.

We have prepared a presentation that summarizes many of the relevant provisions as they currently stand in each version and highlights their differing impact on private equity. This follows our post from last week highlighting the provisions in the House tax bill affecting private equity.
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More on the Senate Mark’s Taxation of Pass-Through Business Income

The Senate’s tax reform mark provides for favorable tax treatment of so-called “pass-through” business income derived by individuals by permitting an individual taxpayer generally to deduct 17.4% of “domestic qualified business income” from a partnership, S corporation, or sole proprietorship. The House tax bill, by contrast, provides a special 25% maximum rate on certain types of business income derived by individuals through partnerships, S corporations or sole proprietorships.

The Senate proposal also introduces a new rule, that is not in the House bill, that would require a non-U.S. shareholder to treat all or a portion of the gain from the sale of an interest in a U.S.
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More on the Senate Mark’s Real Estate-Related Proposals

The text of the Senate Finance Committee’s proposed tax reform bill has not yet been released, but the Senate Finance Committee Chairman’s Mark released in summary form (“Senate Mark”) suggests that it will differ from the House bill as reported to the House floor on November 9 in several material respects. Below, we highlight several of the proposals mentioned in the Joint Committee’s summary that are of interest to the real estate industry.

17.4% Deduction for Certain Pass-Through Income (including REIT dividends).  Subject to the wage limitation mentioned below, the Senate Mark generally allows an individual to deduct 17.4% of its “domestic qualified business income” from a partnership, S corporation, or sole proprietorship.
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Senate Mark at a Glance

The Senate Finance Committee Chairman’s Mark (Senate Mark) released last night diverges sharply in many respects from the House Bill.  Although in summary form, the Senate Mark describes a comprehensive tax reform proposal that will take some time to analyze. In the meantime, the table below summarizes key features of the Senate Mark, together with a comparison to the final House Bill.

We have also released an initial version of our Senate Bill Navigator, a hyperlinked version of the Senate Mark built to ease your navigation of its text, which you can find here.

Corporates.  As expected, the Senate Mark calls for a permanent reduction in the corporate tax rate to 20%, with implementation delayed until 2019.
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Brady’s Second Amendment at a Glance

Chairman Brady released another manager’s amendment to the House Bill this afternoon. This amendment was promptly approved by the House Ways and Means Committee 24-16 and included in the House Bill reported to the floor.

We have incorporated this amendment into the text of the Chairman’s Mark and have generated a PDF comparison showing the revised sections, which you can find here. Click here for a comparison that shows the entirety of the bill’s text. Both comparisons are against the bill as amended on November 6th. We will follow up in the morning with an updated Tax Bill Navigator, reflecting the final bill as reported to the House floor.
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Brady Settles Ambiguity Over SALT Deduction for Pass-Through Income

Confusion as to whether (or how) the House bill’s repeal of the deduction for state and local income taxes would apply to state and local income taxes imposed on an individual’s share of the income received from a pass-through business has been resolved in a letter issued by House Ways and Means Committee Chairman Kevin Brady (R-TX) this morning. Read the full letter here.

The Ways and Means section-by-section summary and the JCT summary released on Saturday both indicate that the deduction is intended to be preserved for state and local income taxes paid or accrued in carrying on a trade or business or producing income.
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The House Tax Bill Provisions Affecting Private Equity

The House tax bill contains several provisions that could significantly affect private equity sponsors, investors and portfolio companies. Below we have highlighted a number of these proposals, including discussions of:

Carried Interest. The House bill generally would limit the favorable taxation of carried interest to investments that have a holding period of more than three years, and treat carried interest attributable to gains on investments held for three years or less as short-term capital gain (taxed at the rates applicable to ordinary income).
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Ways and Means Adopts Amendment Reforming Treatment of Carried Interest

The House Ways and Means Committee has adopted Chairman Kevin Brady’s (R-TX) amendments to the House tax bill containing a provision addressing “carried interest.”  “Carried interest” is the term commonly used for an equity interest in a partnership that entitles the holder to a share of the partnership’s profits that is larger than the holder’s percentage interest in the capital invested in the partnership.  Under current law, a carried interest is treated in the same manner as any other partnership interest, with the result that the character of the income and gains recognized by the partnership (e.g., as long-term capital gain, short-term capital gain or ordinary income) flows through to the partner.
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Brady’s Amendment at a Glance

Last night Chairman Brady released the first set of amendments to the Chairman’s Mark released last Friday. We have incorporated these amendments into the text of the Chairman’s Mark and have generated a PDF comparison showing the revised sections, which you can find here.  Click here for a comparison that shows the entirety of the bill’s text.

In addition to modifying the earned income tax credit, the Chairman’s amendment limits the favorable taxation of “carried interest,” so that long-term capital gains rates will apply only to gains from investments that have been held for more than 3 years. To address concerns around the House bill’s treatment of deferred compensation in the context of start-ups, the amendment also adds a provision that would defer the recognition of income on the exercise of compensatory options or the settlement of restricted stock units issued to certain employees of private companies for up to five years (in limited circumstances).
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Proposed Section 163(j) in the Partnership Context

The bill generally limits the amount allowed as a deduction for business interest to the sum of the taxpayer’s business interest income and 30% of the taxpayer’s adjusted taxable income for the taxable year. In general, a taxpayer’s “adjusted taxable income” is its taxable income, determined by excluding (i) items not attributable to a trade or business, (ii) business interest income and business interest expenses, (iii) any net operating loss deduction, and (iv) deductions for depreciation, amortization or depletion.

In the case of partnerships, the limitation on the deductibility of business interest applies at the partnership level. That means that the deductibility of a partner’s share of a partnership’s business interest is determined by reference to the partnership’s adjusted taxable income, without regard to the amount of the partners’ adjusted taxable income.
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Weekly Roundup: Key Posts and What’s on Deck This Week

Last week was a busy week at Tax Reform And Transition. House Republicans released text of a tax reform bill on Thursday (view the full bill through our Tax Bill Navigator), followed by an official Chairman’s Mark on Friday. Late Friday night, the Joint Committee on Taxation released an official summary of the Chairman’s Mark, together with their assessment of the revenue effects and distributional effects of the Chairman’s Mark.

You can read our grid summarizing the key provisions of the bill here. Here’s a round up of the tax reform topics covered in our more detailed posts so far:


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More on The House Bill’s Real Estate-Related Provisions

The tax reform bill that House Republicans released last week contains a number of provisions that could impact the  real estate industry. We highlight a few of the most significant proposals below:

Business Income of Individuals.  As described in more detail here, the bill proposes a new regime that effectively introduces a maximum 25% tax rate on 100% of passive business income and generally, unless an election is made or the business is a service business, on 30% of active business income.

  • The real estate industry will benefit from the fact that, under the new rules, most rental activity will produce passive business income.

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More on the House Bill’s Proposed Taxation of Pass-Through Income

One of the more anticipated features of the House tax bill was a proposal to apply a special reduced tax rate to business income derived by individuals through sole proprietorships, partnerships and other pass-through entities and arrangements. We have previously written about the proposal from a private equity perspective as well as from an overall tax policy perspective.

The bill follows through on the proposal and introduces a special 25% maximum rate on “qualified business income” derived by individuals, but imposes several limitations on eligibility designed to prevent the conversion of wages and other personal services income into business income.
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The House Tax Bill at a Glance

The draft legislative text released today comes in at over 400 pages, and will take some time to analyze.  In the meantime, the table below summarizes key features of the bill.  In addition, a section-by-section summary prepared by the House Ways and Means Committee is available here.  We have also released an updated version of our Tax Bill Navigator, a hyperlinked version of the bill built to ease your navigation of its text, which you can find here.

As expected, the bill calls for an immediate and permanent reduction in the corporate tax rate to 20%.  The bill significantly limits the deductibility of interest expense for certain businesses, introducing a cap equal to 30% of earnings before taxes, depreciation and amortization, and limits other deductions but provides for immediate expensing of depreciable assets on a temporary basis.  
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The Big Six Framework “Arrives”

The Big Six tax reform framework has arrived, sort of. The Big Six officially released “The Unified Framework for Fixing our Broken Tax Code” this morning, in a format (and in many ways content) that resembles the House Republican blueprint from 2016. Although more detailed than the proposal put forward by the Trump administration in April, the Framework leaves a number of key decisions up to the House and Senate tax writing committees. Without further ado, here is a summary of what the Framework contains:

A few initial observations:

Not a Lot of Detail.  While the framework sets forth a rough outline of a tax reform bill, the level of detail contained in the framework and the number of instances where the framework specifically leaves discretion to the tax writing committees indicates that the plan is very fluid at this stage.
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Prospects for Tax Reform in 2017?

House Speaker Paul Ryan (R-WI) addressed the National Association of Manufacturers on Tuesday in an effort to build support for tax reform, emphasizing the unique, and diminishing, window of opportunity that exists to enact permanent tax reform ahead of next year’s primaries and midterm elections. According to his press office, this speech marks the beginning of his “sales pitch” for tax reform in 2017. Speaker Ryan’s prepared remarks are available here. You can also watch his speech here (starting at 1:41:34).

Here are the key takeaways:

  • Republicans Are Aiming for End of 2017:  Speaker Ryan said that lawmakers would “begin to turn” their plan into legislation to put in front of Congress, and promised to “get this done in 2017.” We have heard this line before, both from Speaker Ryan and from Treasury Secretary Steve Mnuchin during the press conference unveiling Trump’s tax principles.

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President Trump To Announce Tax Reform Principles

The Trump Administration is expected to announce its tax reform plan during a 1:30 PM press conference at the White House today. The Administration is boasting that the tax plan will be “the biggest tax cut and the largest tax reform in the history of our country.” We will be covering the press conference, so stay tuned for our summary and analysis of what is proposed. In the meantime, here are our predictions for what we may see:

  • Corporate tax rate reduced to 15%
  • Pass-through business income also taxed at 15%
  • Repeal the corporate AMT
  • Deemed repatriation of accumulated offshore earnings taxed at 10%
  • No destination-based cash flow tax
  • Shift toward territoriality?

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Tax Reform and the Treatment of Carried Interest

The favorable tax treatment of so-called “carried interest” that is earned by private equity managers gained a considerable amount of attention from both parties during the 2016 presidential campaign. President Trump has repeatedly called for its elimination, a goal that Treasury Secretary Mnuchin reaffirmed in remarks that he made last Friday.

This is not a new issue. In recent years, there has been a series of legislative proposals to turn off the “flow-through” character, in whole or in part, of partnership allocations of long-term capital gain in respect of carried interest and, instead, to treat all or a portion of those allocations as ordinary income.
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The Problem of Pass-Throughs and Tax Reform

Any overhaul of the taxation of business income must address the difficult question of how to deal with pass-throughs. Most businesses in the United States are organized as pass-throughs and, since 1998, pass-throughs have earned more income than C corporations in every year except 2005. (Read the study here.) This post explains the challenges of dealing with pass-throughs in tax reform, and outlines the various ideas on the table.

Current Law Rate Differential.  Under current law, pass-throughs are not subject to U.S. federal income tax at the entity level. Instead the owners take their shares of the pass-through’s taxable income into account for purposes of determining their own tax liability, with the character of the various items of income, gain, loss and deduction generally being determined at the level of the pass-through and flowing through to the owners.
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Tax Reform: A Private Equity Perspective

The Trump administration and House Republicans have each proposed tax law changes that, if enacted, would significantly impact private equity, both directly and (potentially more significantly) through the businesses in which private equity funds invest. The consequences of the proposed changes vary by industry and therefore the proposals may have an uneven impact across the private equity sector.  We highlight a few of the major proposed changes below.

Lower Tax Rates.  The House and Trump plans would cut corporate tax rates to 20% and 15%, respectively.

Treatment of Pass-Through Entities (Including, Potentially, Private Equity Management Companies).  The House plan would tax the “active business income” of pass-through entities at a maximum rate of 25%. 
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Setting the Stage for Comprehensive Tax Reform

Tax reform will be one of the top priorities for the 115th Congress. Hopes for pursuing tax reform to a successful conclusion are high, given one-party control of the government (and exuberant campaign promises). Following the 2016 election, Davis Polk laid out the background and context in which tax reform measures will be considered, with links to summaries of the leading proposals and details on the politics of tax reform. Although life in Washington has moved forward since this memo was published, the key points and players remain the same. Read on for things to watch.

Setting the Stage for Comprehensive Tax Reform, December 2, 2016

 
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