Pass-through Investing for Funds
Why invest through a pass-through (generally limited liability company taxable as a partnership), when the effective federal income tax rate (29.6%-37%) is higher than the effective federal income tax rate for corporations (21%)? Why make your investors go through the hassle of state income tax filings when you can block all of that income and only report at the corporate level?
We have five reasons for you, with different levels of importance, depending on who’s considering the implications:
For income that will be distributed to owners, the additional shareholder level tax on distributions (20% federal, plus state) results in an effective federal income tax rate of about 37%, regardless.
Funds are measured on pre-tax distributions to LPs – tax paid by a corporation reduces these distributions, while tax paid by an LP does not.
Funds investing through partnerships can, by appropriately structuring acquisitions, minimize the impact of the decrease in 2022 of the interest expense limitation to 30% of EBITDA.
Funds investing through partnerships can, by appropriately structuring acquisitions and dispositions, minimize the impact of the 3-year rule on carried interest allocated to the GP.
Funds exiting from pass-through investments can pass-on an additional amortizable basis step-up to a buyer, potentially resulting in a higher sales price.
