More than a year since the legislation was passed by Congress, the impact of the Tax Cuts and Jobs Act (“Tax Act”) on funds, their owners/managers and investors is clearer – but still many unanswered questions remain, requiring further guidance.
In order for hedge fund and private equity (PE) investors to take advantage of some of the sweeping changes brought by the reform, tax planning throughout the year (while always important) takes on even more relevance, as many surprises and tax consequences could be looming.
For example, the Tax Act limits some coveted deductions that most managers were allowed to take on items such as loan interest, and full deductibility of losses for funding their respective businesses. The Tax Act has also eliminated the management fees deduction that investors previously qualified for, and many high-tax state managers are also being hurt by the new cap on state and local tax deductions.
The alternatives industry did however manage to preserve an existing tax break for carried interest. The Tax Act also opted to extend the period required for managers to qualify for a lower rate on their investment/trading profits, rather than getting rid of this advantage altogether.
Hedge and PE fund investors will notice the deduction change when they start to receive their Schedule K-1s from their fund investments, with new lines for calculating interest expense deductions as well as some new disclosures and footnotes that will need to be addressed.
The Tax Act has presented important changes for investors, but has also preserved several areas some thought could have been changed. Business owners might now consider changing their form of business in order to take advantage of the lower corporate tax rate or the lower tax breaks afforded to pass-through entities. Decisions regarding philanthropy have also become more relevant and more important since this is the most viable deduction is now available to investors.
There are many things to think about and rules to navigate when it comes to tax planning. In most if not all situations, multi-year modelling may be required so as to try to get the best tax result now and in future years. For further guidance, please refer to our 2018 Year-End Tax Planning Alert at your leisure and let us know how we can assist you.