Business Owners Waiting for IRS Regulations on S Corp Carried Interests

The IRS regulations on S corp carried interests are up in the air after the IRS’s March 1, 2018, announcement that S corporations are subject to the extended three year holding period for applicable partnership interests.

What does the IRS say about S corp carried interests?

“The Tax Cuts and Jobs Act extended the holding period with respect to certain carried interests (i.e. applicable partnership interests) to three years. The IRS today issued Notice 2018-18 which states that it will be issuing regulations clarifying that taxpayers will not be able to circumvent the three-year rule by using “S corporations.” The IRS Says

Under the tax reform law, the three-year rule took effect for tax years beginning after Dec. 31, 2017. Treasury and IRS intend to issue regulations that are also effective for tax years beginning after that date.

What does this mean?

On March 1, the U.S. Department of the Treasury and the IRS issued clarifying guidance (not regulations) on how the S corp carried interests provisions will be implemented. Regulations will be issued that will not allow taxpayers to avoid the three-year holding period by using the pass through status of the S corp structure.  U.S. Department of the Treasury

More simply put, the guidance notice tells us that regulations pertaining to section 1061(c)(4)(A) do not include the pass through entity S corp in their new definition of “corporation.” This means that S corps, unlike other corporations, will be subject to the new three-year holding period to qualify for capital gains rates and that the regulations are to be effective for taxable years beginning after December 31, 2017. Lexology

How does, or could this affect you?

The quick answer is “who knows?” If the definition of “corporation” has been changed to specifically exclude the S corp, perhaps in the final analysis and regulations yet to be published, the S corp could also be exempt from other highly-coveted (or not) 2017 tax law reforms previously anticipated. These include:

1. 21% flat tax rate for corporations
2. End to the corporate alternative minimum tax rate
3. New qualified business income deductions for pass-through business income
4. Increased and more generous Section 179 deduction rules
5. Liberalized usage of cash and non-inventory accounting methods
6. New limits on interest deductions
7. Stricter rules and limitations for net operating losses and new rules for excess business losses
8. Reduced or eliminated entertainment and employee fringe benefits deductions
9. Section 1031 like-kind exchanges limitation
10. Compensation deductions
11. Certain R&D expenses
12. Expenditures on pre-1936 buildings and certified historic structures

Anything else?

Considering this is a new tax code signed into law before anybody read all of it and the fact that changes have already been made, most anything can still happen and probably will happen. In fact, nearly hourly, the IRS regulations on S corp carried interests are being challenged, and the question has already risen as to “whether the IRS has exceeded its regulatory authority in this case.” The American Institute of Certified Public Accountants has requested immediate IRS guidance on this in late January.

Stay flexible and don’t count on long-term goals as being your major consideration, and maintain solid, close communication with us,  your business tax specialist CPA firm. Good advice for any business owner filing their taxes is to make their 2018 tax planning appointment immediately. Tax filing and tax preparation are not the same things. Tax preparation is the everyday execution of your tax strategy and planning. Tax filing is the presentation of your tax returns.

What’s the bottom line?

If you’ve never consulted with a CPA tax professional for individual and or business tax strategy, now is the year to do it. This is not the time to pit yourself against the IRS or ask someone who took some six-week tax course to explain to you their version of the IRS regulations on S corp carried interests.

You don’t want to be explaining your version of the new IRS IRS regulations on S corp carried interests to an IRS agent! Remember, when it comes to the IRS, you’re NOT right until proven wrong. It’s the other way around.

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