The Tax Cuts and Jobs Act imposes a three-year holding period, rather than a one-year holding period, in order to qualify for long-term capital gains rates with respect to profits interests received in connection with the performance of services by the taxpayer for a partnership or LLC. Gains from profits interests held for three years or less are short-term capital gains subject to tax at ordinary income rates, which could be as high as 37%.
The new tax statute applies to both gain from the sale of profits interests (for example, if the holder of the profits interest sells his or her profits interest to a third party for cash) and gain allocated to a partner with respect to his or her profits interest to the extent the gain relates to the sale of assets held by the partnership or LLC (for example, if the holder of the profits interest does not sell his or her profits interest, but instead the underlying entity sells an asset for a capital gain and allocates some of that capital gain to the profits interest holder).
Accordingly, under the new tax law, both of the following would be subject to tax at the taxpayer's ordinary income rate (and not eligible for capital gains):
- A profits interest holder's share of gain from the sale by the underlying entity of any assets (even a capital asset) disposed of by the underlying entity within the first three years of someone receiving his or her profits interest grant, or
- A profits interest holder directly selling his or her profits interest to someone before having held such interest for three years.
As the new statute does not grandfather partnership interests issued prior to the enactment of the TCJA, partners, partnerships and LLCs should be aware that this new provision may impact partnership interests issued in 2015, 2016 or 2017.
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.