Investment managers’ partnership gains would count as regular income

The proposal describes treating some partnership gains as regular income and limiting when related losses count as ordinary losses. The rules cover interests in partnerships that mainly hold investment assets when a person or related person holds an interest through a business that mainly advises on, manages, buys, sells, or finances those assets. Ordinary losses generally cannot exceed earlier gains treated as ordinary under these rules. Some capital investments are excluded when they receive allocations on the same basis as significant allocations to comparable partners who provide no investment services; special rules cover certain family partnerships. The rules in sections 710(a) and (b) generally would not apply to domestic C corporations, except special-purpose acquisition companies. These rules would apply to tax years ending after enactment. For a partnership tax year that includes enactment, only gains from the period after enactment count.

The proposal describes treating gains from selling certain interests as ordinary income and recognizing gain when partnership property is distributed. These rules apply to investment services partnership interests as defined in the proposal. A gift or transfer at death follows separate rules: the recipient keeps the interest subject to these rules, and the deceased holder’s potential ordinary income is handled under a separate tax rule. Some exchanges for another partnership interest may avoid immediate gain recognition if the taxpayer makes an irrevocable election and follows required reporting and recordkeeping rules. Gain on a property distribution is ordinary only to the extent and in the same way that a hypothetical allocation of gain would be ordinary under the proposal’s other rules. The sale and property-distribution rules would apply to transactions after enactment.

The proposal describes treating certain service-related income as ordinary income and counting specified partnership income or loss toward an individual’s self-employment earnings. The rules cover specified investment services for investment partnerships, certain investment entities, and special-purpose acquisition companies, as further defined in the proposal. The ordinary-income rule applies when a person performs a substantial amount of specified investment services, holds a disqualified interest, and its value or payments are substantially tied to income or gains from managed assets. The self-employment rule covers an individual in the specified services business; it does not include the separate substantial-quantity requirement. The proposal does not extend the domestic C corporation exception to the self-employment rule or the ordinary-income rule for disqualified interests. The rule for other income tied to investment-management services would take effect upon enactment. The self-employment rule would apply to tax years ending after enactment.

The proposal describes a 40 percent penalty for certain underpayments tied to avoiding its investment-services tax rules. The penalty concerns underpayments tied to avoiding the investment-services rules described in the proposal. The 40 percent rate applies to the portion of an underpayment covered by the specified avoidance rules. The reasonable-cause exception applies only if the taxpayer disclosed the relevant facts, had substantial legal support for the tax treatment, and reasonably believed it was more likely than not correct. The penalty changes would apply as provided by the proposal’s effective-date rules.