Guidance to subject S corps to hold period rules for carried interests
The IRS and Treasury recently announced (see Notice 2018-18) that they intend to issue regulations clarifying that the new three-year holding period requirement for applicable partnership interests, enacted as part of the Tax Cuts and Jobs Act (TCJA), will also apply to applicable partnership interests held by S corporations. More specifically, the Notice states the regulations will provide that, for purposes of the new carried interest provisions (now found in section 1061), the term ‘corporation’ will not include an S corporation.
Enacted as part of the TJCA, the highly publicized, and heavily debated, carried interest provisions require a three-year holding period in order for holders of certain partnership interests to receive long-term capital gain treatment. This holding period provision only applies to partnership interests received in connection with the performance of substantial services by the taxpayer, or any other related person, in an applicable trade or business (i.e., an “applicable partnership interest”). However, the provision provides that an applicable partnership interest does not include any interest in a partnership directly or indirectly held by a corporation. It is this language that has been the source of much debate since the enactment of the TCJA in late December, and it is what the planned regulations intend to address.
Based on the flush language of that exclusion, many believed that a partnership interest held by an S corporation would be exempt from the three-year holding period requirement. Indeed, an S corporation is nonetheless still a corporation. However, the Notice indicates that Treasury and the IRS disagree with this interpretation and will clarify in these regulations that the term ‘corporation’ was intended to mean “C corporation.”
For those following the carried interest debate, this guidance likely comes as no surprise. However, it will be interesting to see how the regulations navigate the statutory language, which appears to exclude any interest owned by a corporation, whether that be a C corporation or an S corporation.
