Private equity firms will no longer be able to convert income from management fees into capital gains, which are taxed at a lower rate, under a proposed rule by the IRS published in the Federal Register Thursday.
Classifying a management fee as a capital contribution might be a “disguised payment for services,” the IRS said in the proposal. Partnerships that follow those practices will find them disallowed in cases that do not involve “significant” entrepreneurial risk on the firm’s part, according to the proposal. Lesser weight will be given to five other factors.
The change, which clarifies existing regulations, could be enforced now, but the IRS is accepting public comment until Oct. 21.
The IRS put disguised payment practices at partnerships on their regulatory agenda in 2013. “They are going to take a pretty tough line,” said Steven Rosenthal, a tax lawyer and visiting fellow at the Tax Policy Center in Washington, in an interview. “I think it’s important to give this industry clear guidance.”
The proposal is available here.