On August 5, 2021 Senate Finance Committee Chairman Ron Wyden and Senator Sheldon Whitehouse introduced proposed legislation (the “Ending the Carried Interest Loophole Act,” or the “Proposal”) that would substantially change the U.S. federal income tax treatment of partnership interests issued in exchange for services, commonly known as carried interests, and potentially other types of partnership interests as well. The Proposal would repeal Section 1061, the “three-year carry rule” that was enacted as part of the 2017 tax reform legislation, and instead subject the holder of a carried interest to current inclusions of compensation income, taxable at ordinary income rates, in amounts that purport to approximate the value of a deemed interest-free loan from the partnership’s other investors to the carried interest holder. The Proposal would be effective for taxable years of a taxpayer beginning after the date of enactment, provided that any applicable partnership’s taxable year ends with or within the relevant taxpayer’s year. For most impacted partnerships and partners, if the Proposal were passed anytime in 2021, the provisions would take effect for calendar year 2022.

Although the Proposal would likely be subject to revisions and clarifications before adoption as final legislation, the proposed rules raise, among other issues, potential phantom income and double taxation concerns for investment partnership sponsors, and uncertainties with respect to potential trade or business risks for non-U.S. persons and tax-exempt organizations that purchase carried interests as investors.

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