3-year holding period applies to S corporations

Editor: Sally P. Schreiber, J.D.

On March 1, the IRS announced that S corporations are subject to the new extended three-year holding period applicable to carried interests (Notice 2018-18). It also announced that it plans to issue regulations addressing this rule.

Carried interests are ownership interests in a partnership that share in the partnership’s net profits. They are often transferred in connection with the performance of substantial services by an individual. Proceeds from that individual’s partnership interest are often taxed as capital gain rather than ordinary income.

P.L. 115-97, known as the Tax Cuts and Jobs Act, extended the holding period for certain carried interests (applicable partnership interests) to three years to be eligible for capital gain treatment. Under Sec. 1061(c)(4)(A), “applicable partnership interest” does not include any interest in a partnership that is directly or indirectly held by a corporation.

In Notice 2018-18, the IRS stated that it will issue regulations that provide that the term “corporation” in Sec. 1061(c)(4)(A) does not include an S corporation. This will prevent taxpayers from using an S corporation to get around the three-year holding rule.

The regulations, when finalized, will be effective for tax years beginning after Dec. 31, 2017 — the date the three-year rule took effect.