On March 22, 2021, we posted a blog discussing Section 1061 that was part of the Tax Cuts and Jobs Act. Generally, Section 1061 is effective for tax years beginning after Dec. 31, 2017, and is applicable to partnership partners (individuals, S corps, trusts or estates) that hold its interest in the partnership as compensation for services rendered to the partnership. This is fairly common in partnerships relating to real estate, hedge funds and private equity funds. For a partnership interest that is described in 1061, the partner disposing of the “carried interest” is only eligible for the long-term capital gains rates if the carried interest is held for three or more years.
The IRS has now issued News Release IR-2021-215 and addressed frequently asked questions, offering further guidance on final regulations 1.1061-1 issued last January in T.D. 9945. These specify requirements that both the affected partner and the partnership (and a flow through entity that is a partner such as an S corporation) must comply with when filing their returns. The requirements are effective for returns filed after Dec. 31, 2021.
The IRS guidance will require partnerships to attach a “Worksheet A” (provided in the FAQ) with the partner’s (or the flow through entity’s) Schedule K-1. Worksheet A identifies the proportion of the distributive amount that qualifies for a one-year or three-year holding period. The partner then utilizes Worksheet B to determine the characterization of the distributive amount on their tax return and attaches Worksheet B to the return when filed.
The FAQ document also describes how the taxpayer should specifically report the gains from the disposition of a carried interest on Schedule D.