Interest carried over is that portion of a mutual fund’s returns paid to hedge fund and private equity managers, venture capitalists, and certain property investors who are eligible for lower tax rates.
The tax bill increased the length of time hedge funds and private equity managers had to hold their investments – from one year to three years – to reach the long-term capital gain rate of 20%. Otherwise, they had to pay individual income tax rates, which are now 37%.
However, the 2017 law exempted companies from having to hold assets longer before they qualify for preferential tax rates. Hedge funds have found a way to take advantage of this exemption by creating a number of S companies and limited liability companies for managers who are allowed to split interest payments so they qualify for the lower interest rates faster. So-called C companies, the common structure of most listed companies, are not subject to the three-year holding period.
Some experts question whether the IRS has the power to put this restriction in place through regulation, since the tax law does not put a restriction on the type of businesses that can access the interruption. A recent U.S. appeals court ruling suggested the same thing, saying the IRS may have trouble defending the rules in future litigation.
The rules on interest income are a politically sensitive issue. President Donald Trump promised before the 2017 tax bill to end the tax break, popular with some business-friendly members of his party. The overhaul ultimately reduced the carryforward benefits rather than canceling them out entirely.
Democrats have been proposing laws for years that would end the tax break on interest income. For the most part, these efforts were symbolic because the Democratic-run house failed to get the Republican majority in the Senate on board.
The tax break could be lifted once Joe Biden becomes president, however, as the Democrats now closely control both houses of Congress. The interest rate relief is relatively small for tax expenditures, costing about $ 14 billion in a decade.