Historically, the ability for investment fund managers to take profits in the form of carried interest has allowed those managers to pay the lower long-term capital gains tax rate (compared to income) so long as the partnership’s or corporation’s underlying investments had been held for greater than a year. The Tax Cuts and Jobs Act, passed in late 2017, extended that period to three years. Due to an ambiguity in the new law, a number of managers – particularly hedge fund managers including,  crypto fund managers ,  changed their structures to that they would be treated as taxable S-corporations or taxable passive foreign investment companies (PFICs) that had made certain elections on their tax returns.

Arguably, this change could have resulted in these managers to be able to use the old one-year holding period providing long-term capital gains treatment.

New proposed IRS regulations would make it clear that assets, such as cryptocurrency and security tokens, must be held for three years before an individual or pass-through carried interest recipient could get long-term capital gains treatment regardless of the technical structure of the carry recipient

Among many other things, the proposal should be considered as a warning against a fund manager attempting allocation waivers or other methods reallocating gains or losses so that they are first allocated to non-carry partners if the carry partner cannot get long-term capital gains treatment.  If finalized, this would effectively nullify a number of managers’ attempts to move offshore or create S-corps to avoid revised treatment under the new law.   A detailed alert from Polsinelli’s tax and investment funds teams is available here.