The passage by the U.S. House of Representatives on May 22 of a major tax bill that would enact large portions of President Trump’s tax agenda allows for a clearer picture of what tax policy changes are likely coming for the asset management industry.
The bill passed the House by a slim majority after late changes to certain provisions to appease Republican holdouts, and it now moves to the Senate, where additional significant changes are likely. Republicans aim to enact the bill before the July 4 holiday, although Senate passage could take longer.
Although some uncertainty remains about what will make it into the final bill, asset managers now have more detail on many provisions in play to be included in the final bill, and they can begin planning accordingly. Numerous business tax provisions in the bill would affect asset managers, investors, and portfolio company investments. In addition, there are some notable omissions from the bill of provisions that could be resurrected during the legislative process.
This Alert highlights key provisions of the House tax bill affecting the asset management industry. For a broader discussion of the bill, see BDO’s Tax Alert “House Vote Tees up $4 Trillion Tax Bill for Senate Action.”
Key Provisions of Note for Asset Managers
Effective Elimination of Pass-Through Entity Tax (PTET) Deductions
The bill would effectively eliminate the ability of asset managers to deduct state and local taxes (SALT) for any partnership or S corporation involved in a specified service trade or business (SSTB) to benefit from the current PTET deduction. For tax years beginning after December 31, 2025, deductions for these taxes at the partnership or S corporation level would now only be allowed if less than 25% of the gross receipts were attributable to a SSTB or if at the individual level they were under the SALT cap and gross income thresholds outlined below. The definition of SSTB includes any trade or business “which involves the performance of services that consist of investing and investment management, trading, or dealing in securities … partnership interests, or commodities,” meaning these businesses generally would no longer be entitled to deductions under the PTET regimes.
The legislation removes the temporary $10,000 limit on SALT deductions under Section 164, and instead creates a new permanent limit of $40,000 for both single and joint filers under Section 275 beginning in 2025. The increased cap would begin to phase down to $10,000 when modified gross income exceeds $500,000. The $40,000 cap and $500,000 phaseout would increase by 1% each year from 2026 through 2033 and then remain static.
The Section 275 limit would apply to specified state income, sales, and property taxes (as well as foreign income taxes and taxes paid by cooperative housing corporations), and includes a provision designed to shut down state law pass-through regimes that allow “workarounds” to the SALT cap.
Section 199A Qualified Business Income Deduction Rate Increase
The bill would make the deduction for pass-through income under Section 199A permanent and would increase the deduction rate from 20% to 23% for tax years beginning after Dec. 31, 2025. The bill would also adjust the phaseout of the deduction for taxpayers who do not meet the wage expense and capital investment requirements or who participate in a disqualified “specified trade or business.” The deduction would be reduced by 75% of the amount that the taxpayer’s income exceeds the phaseout threshold (if greater than the deduction allowed by applying the regular limits).
There has been some commentary that the rate increase effectively offsets the loss of the PTET deduction, and while this may be accurate for certain taxpayers, fund managers above the income threshold may not benefit.
Section 199A Qualified Business Income Expanded to Include Certain Business Development Company (BDC) Income
Under additional changes to the deduction for pass-through income under Section 199A included in the bill, qualified BDC interest dividends attributable to net interest income from BDC’s electing to be treated as a regulated investments company (RIC) would now qualify for these favorable rates.
IRA Energy Credits Phaseout and Repeal
The bill would raise more than $500 billion by repealing, restricting, and phasing out many of the energy credits enacted under the Biden administration as part of the Inflation Reduction Act (IRA). Several credits would be repealed at the end of 2025, leaving taxpayers and manufacturers little time to plan to still qualify for these credits.
Changing the Explicit Regulatory Mandate for Rules Under Section 707(a)(2)
The bill would change a reference to regulations under Section 707(a)(2) that could affect fund managers.
Section 707(a)(2) can recharacterize certain transactions involving partners and partnerships. For example, Section 707(a)(2) may operate to treat receipt of partnership interests in exchange for waived management fees or carried interests as a disguised payment for services. If applicable, these rules could result in the fund manager or carry partner recognizing ordinary income subject to higher rates of tax compared to capital gains. Additionally, certain contributions of cash to a partnership followed by a distribution to the partners may be recharacterized as a purchase of partnership interests from the selling partners. This recharacterization could result in the recognition of additional taxable gain by the “selling” partner.
The statute is currently drafted to provide that Section 707(a)(2) operates “under regulations prescribed by the Secretary.” To date, no regulations have been finalized addressing disguised sales of partnership interests. Further, Treasury and the IRS have only published proposed regulations addressing disguised payment for services. Given the structure of the statute, it is arguably questionable whether these rules are operable in the absence of regulations. Further, following the Supreme Court’s decision in Loper Bright Enterprises, et al v. Raimondo, it’s unclear whether regulations published under Section 707(a)(2) will be respected by the courts.
The bill would modify the statute to provide that Section 707(a)(2) operates “except as provided by the Secretary.” This appears to clarify that the statute operates even in the absence of regulations. Further, the amendment would appear to delegate significant authority to the Treasury and IRS to provide operational rules.
Active Business Losses Under Section 461(l)
The bill would make the active loss limit under Section 461(l) permanent, and it would also require taxpayers to separately track and carry forward disallowed losses to be applied in calculating the Section 461(l) limit in subsequent years. Under current law, a disallowed loss under Section 461(l) generally becomes a net operating loss (NOL) in subsequent years. This allows taxpayers to use an NOL created by Section 461(l) against other sources of income in future years, causing Section 461(l) to act more like a one-year loss deferral mechanism for many taxpayers. The change creates a potentially longer term for disallowed losses.
Additional Tax Withholding on Foreign Persons in ‘Discriminatory Foreign Countries’
The bill would add new Section 899, which would impose retaliatory taxes on residents of “discriminatory foreign countries” that impose “unfair foreign taxes.” This would essentially raise the tax and withholding rates for affected foreign taxpayers on several types of income. The definition of unfair foreign taxes is relatively broad and includes the undertaxed profits rule under Pillar Two, digital service taxes, and “any other tax with a public or stated purpose indicating the tax will be economically borne, directly or indirectly, disproportionately by United States persons.” The additional rates imposed under the legislation would not replace treaty rates, but it would impose additional incremental tax on top of treaty rates.
Partnership Reporting on Specified Service Trade or Business Income
Under the bill, partnerships and S corporations would need to include a statement on their tax returns and Schedules K-1 on whether they had any gross receipts from a specified service trade or business, as described in Section 199A(d)(2).
Provisions Affecting Portfolio Company Investments
Section 163(j) Limit on the Interest Deduction
The bill would reinstate the more favorable calculation of the limit on the interest deduction under Section 163(j) for tax years beginning after Dec. 31, 2024, and before Jan. 1, 2030. Section 163(j) generally limits the interest deduction to 30% of adjusted taxable income (ATI). For tax years beginning after 2021, current law requires ATI to include amortization, depreciation, and depletion. The bill would once again remove amortization, depreciation, and depletion from the ATI calculation. If enacted, highly leveraged portfolio companies may have an opportunity to temporarily use suspended interests. Modeling out the interactions with other provisions will be critical for effectively using tax attributes.
Bonus Depreciation
The bill would restore 100% bonus depreciation for property placed in service after Jan. 19, 2025, and before Jan. 1, 2030. There would be no phasedown beyond these dates, so property placed in service in 2030 or later would not qualify for any bonus depreciation amount. The change has potential applicability to funds when purchasing interests in a partnership creating a Section 743(b) adjustment.
Expansion of Qualified Small Business Stock (QSBS) to Include Section 174A Research Expensing
The bill would restore expensing of domestic research costs for tax years beginning after Dec. 31, 2024, and before Jan. 1, 2030. The legislation would not reinstate the expensing rules under Section 174, but it would instead create temporary rules under new Section 174A, similar to the Section 174 rules before the TCJA changes. Taxpayers would retain the option of electing to capitalize domestic Section 174 costs and amortize such amounts over 10 years or the useful life of the research (with a 60-month minimum). Foreign research would still need to be amortized over 15 years.
Deductions for Overtime Pay and Tip Income
Following on President Trump’s campaign promises, the bill would provide a deduction equal to qualified overtime compensation, as well as a deduction equal to the amount of qualified tips reported on Forms W-2, 1099-K, 1099-NEC, or 4317. These deductions would be allowed from 2025 through 2028 without regard to whether a taxpayer itemized deductions. These new deductions will carry certain reporting requirements and compliance complexities, impacting portfolio companies with eligible employees.
Provisions Affecting Investors
Excise Tax on Investment Income of Certain Private Colleges and Universities
Net investment income of certain educational institutions is currently subject to an excise tax of 1.4%. The bill would impose a new rate structure with excise taxes up to 21%. For institutions with an adjusted student endowment over $500,000 and not exceeding $750,000, the rate would remain 1.4%. For institutions with adjusted student endowment over $750,000 and not exceeding $1,250,000, the rate would be 7%. For institutions with adjusted student endowment over $1,250,000 and not exceeding $2 million, the rate would be 14%. For institutions with adjusted student endowment over $2 million, the top rate of 21% would apply. The proposal would be effective after 2025.
Private Foundation Excise Tax
Under the bill, certain private foundations would see the rate of tax on net investment income increase from 1.39% up to as high as 10%, based on the fair market value of all the “assets” of the foundation as of the close of its tax year. For this purpose, assets are defined to be “applied without reduction for any liabilities,” i.e., gross assets, thereby looping in more foundations into the higher excise rates.
Revocation of Income Exclusion for Certain Foreign Governments
The bill would revoke the exemption under Section 892(a) for certain types of income received by foreign governments in the case of governments deemed a “discriminatory foreign country” (described further above).
Notable Omissions from the Tax Bill
Carried Interest
Although President Trump had expressed support for eliminating the carried interest “loophole,” no provision was included in the House’s bill. Given the President’s expressed support and the fact that the provision would be a revenue raiser, it could still come into play in the Senate if the bill’s deficit effects become a sticking point.
Other Proposed Legislative Changes Not Included
Several other notable provisions floated in preparing the tax legislation did not make into the House’s bill, including: (1) changes to taxation of municipal bonds, (2) changes in individual income tax rates to add a higher “millionaire” tax rate, (3) changes to the 1% stock buy-back tax, and (4) the creation of a corporate SALT deduction limitation.
Next Steps
Although it faced some hurdles, the relatively quick passage of the bill in the House marked a significant step forward in the legislative process. The bill must still pass in the Senate, where it is expected to undergo further significant revisions. The House and Senate will then have to reconcile the differences in their two bills. Republicans’ goal is to enact the bill by the July 4 holiday, but action in the Senate could drag on towards the August recess.
Senate Republicans could seek a variety of changes to the bill, including softening the cuts to energy credits, further amending the SALT cap provisions, making permanent the changes to bonus depreciation and other business provisions, and adjusting the new reciprocal tax on “unfair foreign taxes.”
In addition to internal Republican debates overall specific provisions, the cost of the bill remains a significant hurdle for the bill in the Senate. Many moderate Senate Republicans are uncomfortable with the House’s spending cuts. Some Senate deficit hawks, meanwhile, are deeply committed to the aggressive spending cuts and wary of large tax cuts without offsets.
Please visit BDO’s Asset Management, Tax Policy, and Partnership Tax Services pages for more information on how BDO can help.