TaxJourney®

A recent decision demonstrates that satisfying the mechanical 70/30 overlap test alone is insufficient to protect a basket hedge where the transaction’s economics indicate that its principal purpose was tax savings.

On August 6, 2026, the U.S. Tax Court issued its opinion in SIH Partners LLLP v. Commissioner, 167 T.C. No. 8. At issue was a portfolio swap that, on its face, satisfied the well established “70/30” mechanical test used to hedge appreciated stock positions. The Court nonetheless concluded that the transaction violated the anti-abuse rule contained within the same regulation, and accordingly denied the taxpayer qualified dividend income (QDI) treatment and the associated foreign tax credits.

The Governing Rules

Dividends generally qualify for reduced tax rates under Section 1(h)(11), and withholding taxes on those dividends can generate foreign tax credits under Section 901(k). Both benefits, however, are conditioned on satisfying minimum holding period requirements. Both provisions incorporate the holding period rules of Section 246(c), which exclude any period during which a taxpayer’s risk of loss on a stock was diminished by holding “substantially similar or related property.”

Treasury regulations under Section 1.246-5 define that phrase for basket style hedges. A short position referencing 20 or more unrelated issuers is treated as a “portfolio position,” and such a basket is considered substantially similar or related to a taxpayer’s long stock only where substantial overlap exists between the two. The regulation establishes a bright line, mechanical threshold for that overlap of 70%.

This mechanical test has long supported a common structure: hedging an appreciated stock by shorting a basket in which the appreciated name constitutes less than 70% of the basket’s value, with the remainder composed of unrelated names. Where the appreciated name falls below that 70% threshold, the basket is treated as a single “portfolio position” rather than disaggregated into individual single-stock shorts, subject only to a backstop anti-abuse rule that market participants have generally understood to apply narrowly.

That anti-abuse rule nonetheless treats a multi-stock position as substantially similar or related property where (1) the position is reasonably expected to virtually track the taxpayer’s long stock, whether directly or inversely, and (2) the position is part of a plan whose principal purpose is to generate tax savings that significantly exceed the plan’s expected pre-tax profit.

The Transaction at Issue

SIH Partners, an affiliate of Susquehanna International Group, held long positions in four Swiss companies, Nestlé, Novartis, Roche, and Swisscom, across their respective dividend record dates. Concurrently, the taxpayer offset its exposure to those same four stocks through a portfolio swap with Morgan Stanley.

This swap was not a standalone hedge constructed solely for the Swiss positions. It was incorporated into a pre-existing, firmwide basket of broad market index shorts that SIH maintained for general risk management purposes. The addition of the market index shorts reduced the Swiss names to approximately 64% of the basket’s total value, below the 70% mechanical threshold. Notwithstanding this dilution, the short position in each individual Swiss stock was sized to fully offset the corresponding long position.

For the 2012 tax year, SIH treated approximately $170.8 million of dividends from these positions as qualified dividend income and claimed approximately $25.6 million in associated foreign tax credits, while remitting approximately $130.2 million in substitute dividend payments to Morgan Stanley under the swap. The composition of the swap was not static; SIH adjusted it more than 200 times during the year, with a significant number of these adjustments timed to coincide with the Swiss dividend dates, thereby preserving the offset between the long and short positions.

How the Court Ruled

The Internal Revenue Service’s principal argument, that the swap should be treated as a series of separate single-stock short positions under a substance over form theory, was rejected by the Court. The Court concluded that the transaction constituted a genuine portfolio swap, both in form and in substance, and observed that the applicable regulations expressly contemplate that a basket’s composition will change over time.

The Court further agreed that the mechanical 70% test had been satisfied. At approximately 64% overlap, the Swiss stocks fell below the threshold, and the basket accordingly qualified for the portfolio exception on its face.

The anti-abuse rule produced a different result. In applying the virtual tracking prong, the Court did not evaluate the swap in its entirety against SIH’s Swiss holdings. Instead, it examined the individual components of the basket, specifically the Swiss stock legs, and determined that those legs, considered in isolation, constituted an exact offset to SIH’s long positions and therefore did virtually track them.

With respect to the second prong, the Court found that SIH’s own contemporaneous projections reflected expected pre-tax profit of no more than approximately $2.4 million, a figure substantially exceeded by tax savings in excess of $25 million. The Court concluded that this disparity satisfied the anti-abuse rule’s principal purpose requirement, without making an explicit finding regarding SIH’s subjective intent. The magnitude of the disparity between the tax benefit and the expected pre-tax profit was determinative.

Having concluded that both prongs of the anti-abuse rule were satisfied, the Court held that the Swiss stock holdings constituted substantially similar or related property. This holding shortened SIH’s holding period for the relevant shares, thereby defeating both QDI treatment under Section 1(h)(11) and the foreign tax credits claimed under Section 901(k).

Why This Matters Beyond the Four Corners of the Case

The most consequential aspect of this opinion is the Court’s component level application of the virtual tracking test. Rather than assessing whether the basket as a whole tracked the taxpayer’s stock, the Court assessed whether any individual component of the basket did so, and applied that narrower analysis to reach a result the mechanical test was designed to preclude.

This reading is textually contestable. The regulation’s anti-abuse language refers to changes in value of “the position or the stocks reflected in the position,” and a reasonable argument exists that this language refers to the basket in its entirety rather than to a selected subset of its constituent names. Under the Court’s approach, however, a basket may fail the anti-abuse test even where the remaining 30% or more of the basket carries genuine, independent market risk that would ordinarily preclude the position as a whole from tracking the appreciated stock.

As a practical matter, the mechanical 70/30 safe harbor remains available, but its protective scope has narrowed considerably, particularly for structures in which the anticipated tax benefit clearly exceeds the anticipated economic return. A basket constructed around a precise single-name offset is now considerably more susceptible to disaggregation by the Service, even where that offset is embedded within a larger, diversified position.

The Court did not adopt a categorical rule that all 70/30 baskets fail the anti-abuse test. Both prongs must still be satisfied, which preserves room for taxpayers able to demonstrate a genuine investment, financing, or hedging rationale, and for structures that retain meaningful basis risk rather than a precise, dollar-for-dollar offset. A basket rebalanced less frequently may also be better positioned, although the opinion does not confine its reasoning to actively managed positions coordinated with dividend dates.

Implications Beyond QDI and Foreign Tax Credits

The direct issues in SIH Partners concerned qualified dividend treatment, the dividends received deduction, and foreign tax credits. The Section 1.246-5 definition of “substantially similar or related property,” however, is not confined to this context. It is cross-referenced elsewhere in the Internal Revenue Code, and the Court’s reasoning may extend to those provisions as well.

The stock straddle rules under Section 1.1092(d)-2 incorporate the same definition, raising the possibility that a basket previously treated as a single, undifferentiated position could be recharacterized as creating a straddle, with attendant risk of suspended holding periods and deferred loss recognition.

The application of this reasoning to constructive sale planning under Section 1259 presents a closer question, as that provision does not fully incorporate Section 1.246-5 into its own analytical framework, and the Court did not decide whether a 70/30 basket constitutes an offsetting notional principal contract for constructive sale purposes. Nonetheless, market participants have historically relied on the same regulatory framework, related cure provisions, and legislative history to support basket opacity in the constructive sale context, and the Court’s willingness to examine the components of an otherwise compliant basket may undermine that position. Comparable reasoning could eventually be advanced in the wash sale context as well.

Bottom Line

SIH Partners does not eliminate the viability of the 70/30 basket hedge. It confirms, however, that the Service and the courts retain the authority to look beyond a mechanically compliant structure and disaggregate it to the individual stock level where a hedge produces precise, single-name offsetting exposure and the anticipated tax benefit substantially exceeds the anticipated economic profit. Pending further clarification, narrowing, or appellate review, taxpayers and their advisors should treat bespoke baskets constructed primarily to hedge a single appreciated position, particularly where tax deferral is the principal objective and anticipated pre-tax profit is minimal, as presenting materially greater risk than the mechanical test alone would suggest.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2026 Small World Business Advisors LLC www.swbadvisors.com

The US Court of Appeals for the Fifth Circuit has issued a revised opinion in Sirius Solutions, L.L.L.P. v. Commissioner of Internal Revenue (No. 24-60240), holding that a “limited partner” for purposes of Section 1402(a)(13) of the tax code is a partner who does not assume a significant role in managing or operating a business. This establishes a fact-intensive test requiring examination of a limited partner’s actual involvement in the partnership.

In reaching this conclusion, the court withdrew its own prior opinion in the same case, which had established a bright-line rule: under that earlier approach, any partner in a state-law limited partnership who possessed limited liability was automatically entitled to the exclusion for self-employment tax purposes (commonly referred to as the “SECA limited partner exception”). The new opinion does not specify how courts should assess whether a partner’s role rises to the level of “significant,” and the Fifth Circuit has remanded the case to the Tax Court to interpret and apply the newly articulated standard.

Why This Matters

The revised opinion adds further uncertainty to the ongoing debate over how the SECA limited partner exception should be applied. Although the Fifth Circuit continues to reject the functional-analysis approach the Tax Court adopted in Soroban v. Commissioner, 161 T.C. 310 (2023), the court’s new “no significant role” standard is arguably closer to the Soroban line of reasoning than the Fifth Circuit’s own withdrawn opinion, which had looked exclusively at whether a partner carried limited liability under state law.

Under the revised standard, the exclusion is not limited to partners who are purely passive investors; it may extend to limited partners with some degree of involvement in the business, provided that, upon examination of their management and operational activities, that involvement is found not to be significant.

Actions to Consider

Limited partners in a state-law limited partnership who participate in managing or running the partnership’s business should continue to monitor developments in this area and consult their advisors regarding tax reporting, including any potential disclosure obligations.

Background

Sirius Solutions, L.L.L.P. (Sirius), a business consulting firm organized as a Delaware limited liability limited partnership and treated as a partnership for U.S. federal tax purposes, allocated ordinary business income or loss to its limited partners. Sirius excluded those limited partners’ distributive shares from the computation of net earnings from self-employment.

After the IRS challenged Sirius’s position on audit, its general partner petitioned the Tax Court for review. In a motion for summary judgment, the general partner argued that ordinary business income allocated to the limited partners should be excluded from net earnings from self-employment solely because those partners were limited partners under state law. On August 8, 2022, the Tax Court denied the motion, citing genuine disputes of material fact regarding Sirius’s operations and an unresolved legal question concerning the meaning of “limited partner.”

On November 28, 2023, in *Soroban Capital Partners LP v. Commissioner*, the Tax Court observed that “Congress intended section 1402(a)(13) to apply to partners that are passive investors” and held that determining whether a state-law limited partner qualifies for the SECA limited partner exception requires an inquiry into the partner’s functions and roles. Under that decision, a limited partner who actively participates in the partnership’s business may be unable to exclude his or her distributive share of income or loss from net earnings from self-employment.

Following the Soroban decision in late 2023, Sirius Solutions, L.L.L.P. concluded that the decision was controlling based on the facts at issue and requested that the Tax Court issue an order permitting an appeal to the U.S. Court of Appeals for the Fifth Circuit. The Tax Court subsequently entered a stipulated decision in favor of the IRS on February 20, 2024.

In January 2026, the Fifth Circuit issued an opinion rejecting the functional analysis test established in Soroban and holding that eligibility for the SECA limited partner exception depended solely on whether the partner had limited liability. Following a petition for rehearing filed by the government, the Fifth Circuit withdrew its January 2026 opinion on August 12, 2026, and issued a revised opinion addressing the treatment of limited partners for purposes of the SECA exception.

The Fifth Circuit’s Revised Interpretation

Whereas the Tax Court in Soroban and the Fifth Circuit in its withdrawn opinion had each focused on the statutory phrase “limited partner, as such,” the Fifth Circuit’s new opinion instead examines the underlying meaning of “limited partner” itself. Observing that neither the statute nor its legislative history defines the term, the court determined that the ordinary public meaning of “limited partner” as of 1977 — when the SECA limited partner exception was enacted — was a partner who plays no significant role in managing or running a business.

Under this standard, a limited partner is not necessarily confined to a purely passive role; some degree of participation in the partnership’s business is permissible. However, a partner who exercises control over the business cannot qualify as a limited partner for purposes of the exception. As a result, while the Fifth Circuit’s new standard is somewhat more permissive than the passive-investor test applied in Soroban — itself derived from the functional-analysis approach the Tax Court first articulated in Renkemeyer v. Commissioner, 136 T.C. 137 (2011) — the court declined to preserve a bright-line rule under which limited partner status alone would guarantee application of the exception.

Observations

• Fact-specific analysis required. In light of this opinion, limited partners will need to evaluate the specific facts and circumstances of their involvement in managing or operating a partnership to determine whether the SECA limited partner exception applies. The opinion does not provide guidance on how the “no significant role” standard should be applied in practice; that task has been left to the Tax Court on remand.
• Continued IRS scrutiny likely. The IRS has maintained a compliance initiative targeting the application of self-employment tax to partnership income since 2018. This opinion reinforces the IRS’s position and may support continued examination of limited partners’ status on a facts-and-circumstances basis across jurisdictions.
• Potential for a circuit split. The Soroban case remains on appeal before the Second Circuit, which heard oral argument on June 25, 2026. Separately, the Tax Court applied the functional-analysis test in Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114, which is currently on appeal before the First Circuit. The First Circuit heard oral argument on February 5, 2026, and has requested supplemental briefing on procedural issues arising under TEFRA. As of this writing, neither the First nor the Second Circuit has issued a ruling. Should either court adopt an interpretation of “limited partner” that differs from the Fifth Circuit’s, a split among the circuits could result.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2026 Small World Business Advisors LLC www.swbadvisors.com

On February 25, 2026, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury released IRS Notice 2026-17, previewing proposed regulations under Internal Revenue Code Section 987. The Notice aims to simplify the foreign currency rules applicable to Section 987 qualified business units (“QBUs”), reduce administrative complexity, and provide more practical compliance outcomes for multinational taxpayers.

Under Section IRC Section 987, taxpayers must determine the taxable income of a QBU in its functional currency and translate that amount into U.S. dollars using the average exchange rate for the taxable year, while also accounting for transfers of property between a QBU and its owner. Final regulations issued in December 2024 under Treasury Decision 10016 established a comprehensive framework for these calculations, generally requiring the use of the foreign exchange exposure pool (“FEEP”) method.

IRS Notice 2026-17 introduces several proposed measures intended to streamline these rules and provide greater administrative flexibility.

IRC Section 987 Framework: Key Considerations

• The Notice introduces an equity and basis pool method, broadly consistent with the 1991 proposed regulations, as an alternative computational approach for taxpayers that have made a current rate election under IRC Section 987. Under this method, each item of income, gain, deduction, or loss attributable to a QBU is computed in the QBU’s functional currency and translated into the owner’s functional currency using the average exchange rate for the taxable year.

• Net unrecognized IRC Section 987 gain or loss is determined by comparing the equity pool, measured in the QBU’s functional currency and translated at the spot exchange rate on the last day of the tax year (or termination date), with the basis pool maintained in the owner’s functional currency. Adjustments may be required to reflect the impact of IRC Section 987 hedging transactions.

• Recognized IRC Section 987 gain or loss is generally determined by multiplying the owner’s net unrecognized IRC Section 987 gain or loss by the remittance proportion. The remittance proportion generally equals the amount of the remittance divided by the sum of (i) the equity pool, (ii) the QBU’s liabilities, and (iii) the remittance amount, each measured in the QBU’s functional currency. If a taxpayer makes an annual recognition election, the remittance proportion equals one, resulting in full recognition of IRC Section 987 gain or loss for the year. The election is subject to the consistency requirements of the final regulations and is generally made by attaching a statement to a timely filed tax return, without requiring prior IRS consent. The election does not apply to QBUs owned through partnerships or S corporations, although similar approaches may qualify as reasonable methods under the regulations.

• The Notice also proposes refinements to the loss suspension rules under the final Section 987 regulations. Currently, losses may be suspended to prevent selective recognition of large currency losses. Under the proposed approach, loss suspension would apply only when (i) the remittance proportion exceeds five percent or (ii) the total amount of unrecognized or deferred IRC Section 987 losses exceeds $5 million, thereby significantly narrowing the scope of the existing rules.

• The Notice further simplifies the recognition grouping rules that apply to the loss-to-the-extent-of-gain limitation. For domestic corporate owners, all IRC Section 987 gains and losses would generally be treated as belonging to a single recognition group, allowing suspended losses to be recognized against gains across different foreign tax credit categories. For controlled foreign corporations (“CFCs”), recognition groupings remain limited to tentative tested income, subpart F income, income described in Section 952(b), and other income.

• In addition, it clarifies the deferral rules applicable when a QBU terminates and its assets are transferred to another QBU within the same controlled group. Deferral of IRC Section 987 gain or loss would apply only where a successor deferral QBU reflects a “significant portion” of the operating assets of the terminated QBU. Under the existing regulatory framework, more than 30 percent of operating assets will constitute a significant portion in all cases, while less than 10 percent will not, with determinations between those thresholds based on the facts and circumstances.

• It expands the definition of IRC Section 987 hedging transactions. Certain hedges that do not meet U.S. GAAP hedge accounting requirements may nevertheless qualify if they are primarily entered into to manage exchange rate risk associated with an interest in the QBU that would be treated as debt or stock if the QBU were a separate corporation. For hedges entered into before April 26, 2026, transitional relief permits taxpayers to treat hedges as timely identified if they are properly designated under the regulations before that date and substantially all hedges related to the QBU for the tax year are identified as IRC Section 987 hedging transactions.

Anticipated Regulations for CFCs (Section – 5)

The Notice also outlines anticipated regulations that would allow CFCs to elect out of recognizing foreign currency gain or loss under Internal Revenue Code Section 987.

If the election is made, any previously unrecognized Section 987(3) gains or losses arising before the election would generally be recognized ratably over 120 months. The proposed framework also contemplates special rules for inbound reorganizations or liquidations involving a CFC, including the possibility of a Section 987 basis increase reflecting currency-related adjustments.

Applicability and Public Comment

Taxpayers may rely immediately on the rules described in Sections 3 and 4 of IRS Notice 2026-17, provided that the rules are applied consistently across the taxpayer’s Section 987 electing group. Reliance on the proposed CFC election rules will be permitted once additional guidance is issued.

The IRS and Treasury have invited public comments by April 26, 2026, particularly with respect to the methodology for determining the proposed Section 987 basis increase and whether the rules should apply to partnerships with CFC partners.

Key Takeaways

Multinational groups should consider evaluating whether the equity and basis pool method aligns with their current compliance approach, assessing the impact of the revised loss suspension thresholds, and reviewing existing hedging arrangements in light of the expanded definition of qualifying hedges.

Organizations may also wish to monitor forthcoming guidance regarding the proposed CFC election and consider providing comments on the proposed framework. Early evaluation of these developments may help taxpayers position themselves to benefit from potential simplifications under the evolving Section 987 regulatory regime.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2026 Small World Business Advisors LLC www.swbadvisors.com

Disclaimer: This article may be out of date and recent developments on this topic may render the provisions of this article inapplicable.

---

On January 16, 2026, the U.S. Court of Appeals for the Fifth Circuit ruled that state‑law limited partners in a business consulting partnership can qualify for the self‑employment tax exception on their distributive shares without examining what they actually do in the business.

The court held that a partner’s allocations in a limited partnership fall within the statutory exception from self‑employment tax as long as the partner has limited liability. In a 2–1 decision, the Fifth Circuit set aside the Tax Court’s earlier view, which had restricted the exception to individuals who functioned as “passive investors.” The court rejected that “passive investor” framework entirely, concluding that for purposes of IRC §1402(a)(13), a “limited partner” is defined by limited‑liability status under state law.

The decision has also been noted for its implications for fund managers, as it confirms that limited partnership structures can be used to prevent the application of self‑employment taxes.

The statutory backdrop (what §1402(a)(13) does) 

Self-employed individuals, including partners in businesses organized as partnerships, are generally required to pay self-employment tax (covering Social Security and Medicare) on their earnings. 

For purposes of calculating what counts as earnings subject to that tax, IRC §1402(a)(13) excludes a limited partner’s distributive share of partnership income and loss, except for certain guaranteed payments tied to services. The statute itself specifies that the exclusion applies to “the distributive share of any item of income or loss of a limited partner, as such,” but brings guaranteed payments for “services actually rendered” back into the tax base. 

The provision was originally enacted to prevent individuals from boosting their net earnings from self-employment through partnership allocations that were not tied to actual services, an approach that could have increased Social Security benefits. 

The case background (Sirius Solutions)  

Sirius Solutions was a business consulting firm structured as a Delaware limited liability limited partnership. During the years under review, the firm allocated all of its ordinary business income to its limited partners and reported zero net earnings from self-employment for them, taking the position that the §1402(a)(13) limited partner exception applied. The IRS challenged that treatment, arguing that the individuals labelled as limited partners did not qualify as “limited partners” for purposes of the self-employment tax exception. 

How the Tax Court arrived at the “passive investor” standard (Soroban and later cases) 

While the Sirius case was still before the Tax Court, the court issued its opinion in Soroban Capital Partners, which involved an IRS challenge to a similar position taken by an investment management firm structured as a limited partnership. 

In Soroban and the cases that followed, the Tax Court applied a functional analysis, examining what the limited partners actually did in the business to determine whether their roles resembled those of passive investors. After Soroban was decided, Sirius and the government agreed that the reasoning in Soroban dictated the outcome, leading the Tax Court to rule for the government. Sirius, however, maintained that Soroban was wrongly decided and took the case to the Fifth Circuit. 

The Soroban decision was seen as disrupting planning strategies used by private fund managers who relied on limited partnership structures. A later case, Denham (2024), reinforced the IRS’s challenges to these structures, with both Soroban and Denham concluding that certain mixed roles described in the litigation could not qualify for the limited partner exception. 

What the Fifth Circuit said (the new standard) 

The Fifth Circuit concluded that a partner in a limited partnership qualifies as a “limited partner” for purposes of the §1402(a)(13) exception so long as the partner has limited liability. Under this approach, there is no need to examine a partner’s day‑to‑day responsibilities or level of involvement in the business, an explicit break from the functional analysis used by the Tax Court in Soroban. 

The court’s reasoning rests on the premise that a person is a limited partner if they hold limited‑liability status under state law, a view the court supported by looking to how the term “limited partner” was defined in dictionaries when §1402(a)(13) was enacted. 

The Fifth Circuit also rejected the idea that a limited partner must be purely passive. It noted that if limited partners were never permitted to provide services, the statutes carve‑back for guaranteed payments for “services actually rendered” would serve no purpose. 

The court further criticized the Tax Court’s functional test as creating substantial compliance burdens, characterizing it as a process that would require extensive professional analysis and a fair amount of luck. 

Finally, the Fifth Circuit applied its reading of the phrase “as such” in §1402(a)(13) to clarify how the exception applies when an individual holds both limited partner and general partner interests, distinguishing between amounts allocated or paid in each capacity. 

Why this matters (implications and who could care) 

Although Sirius involved a consulting partnership, the Fifth Circuit’s reasoning does not hinge on the type of business involved. As a result, the decision appears relevant to other industries, such as investment management, so long as they operate through state law limited partnerships. This is also the first Court of Appeals decision addressing whether a state law limited partner can qualify for the §1402(a)(13) exception even when the individual is not a passive investor. 

Many private fund managers had restructured their limited partnership arrangements after Soroban, Denham, and the original Tax Court outcome in Sirius. The Fifth Circuit’s ruling effectively revives the planning approach that relies on the limited partner exception. 

While the decision is not binding on the IRS in cases appealed to other circuits, it may give taxpayers who previously accepted the IRS position a basis to consider refund claims or restructuring to once again claim Social Security tax exemptions for limited partners. Entities taxed as partnerships that have not previously used the limited partner exception may also want to consider protective filings to preserve the option of a future refund claim. 

Scope limits and what’s next (other entity forms + pending cases) 

The Fifth Circuit noted in a footnote that its opinion does not address whether owners of other entity types, such as LLPs or LLCs, might also qualify for the §1402(a)(13) exception. The Tax Court has previously refused to apply the limited partner exception to partners in LLPs and members of LLCs, relying on reasoning similar to what it used in Soroban. 

Although the Fifth Circuit focused on limited liability status and emphasized that the “limited partner” label itself is not determinative, its analysis suggests that similar arguments could potentially extend to other entity forms, while making clear that the court was not deciding those issues. 

The ruling also conflicts with several Tax Court decisions, including cases now on appeal in the First Circuit (Denham Capital Management) and the Second Circuit (Soroban). The outcomes of those appeals will be especially important for taxpayers located outside the Fifth Circuit. 

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2026 Small World Business Advisors LLC www.swbadvisors.com

Heading into 2026, private equity is regaining momentum, supported by a steadier operating environment. Following a prolonged period marked by macroeconomic uncertainty and structural transformation, the industry has come through more robust, more adaptable, and well‑placed to deliver durable long‑term results. PE has re‑established its footing by opening up new opportunities through advances in technology, the adoption of updated operating models, broader investor access to the asset class, and the continued evolution of its overall trajectory. The trends now shaping the sector suggest that PE has moved past a reactive stance and is actively steering its own direction.

Private Credit’s Expanding Spectrum: High‑Yield, Investment‑Grade, and Emerging Segments

Private credit’s role within private equity is rapidly solidifying, supported by a U.S. market that has doubled since 2019 to almost $1.3 trillion and backed by more than $400 billion in undeployed capital. Though recent bankruptcies highlight the importance of underwriting discipline, leveraged‑loan markets remain quiet. With private credit extending into new structures, the $40 trillion investment‑grade segment offers a compelling expansion path.

Banks and private lenders are increasingly operating in overlapping territory, with banks channelling more capital into private credit vehicles. This reflects a wider recalibration in the market: borrowers now favour rapid execution, deal certainty, and tailored terms over legacy financing models. In this environment, private credit delivers adaptable, demand‑responsive solutions and substantial expansion opportunities for PE firms.

How Technology Is Reshaping the Private Equity Lifecycle

Technology integration is reshaping private equity, as firms embed digital tools across the investment process to address rising demands from investors and stakeholders. Fundraising momentum is consolidating among the largest firms, with limited partners prioritizing scale, operational sophistication, and platform capabilities. Mid‑market firms are differentiating through sector focus, agility, and specialized expertise. Regardless of size, long‑term success hinges on strategic clarity, disciplined delivery, and the ability to generate value, enabled by data, technology, and artificial intelligence.

AI is no longer confined to discrete functions. Leading firms are rethinking its application across the entire investment journey, from sourcing opportunities to final exit. This marks a broader transition: technology is evolving from an efficiency play into a strategic catalyst for differentiated value creation. To harness this, firms are channeling resources into proprietary platforms, predictive analytics, and digital infrastructure, unlocking fresh performance levers.

They are also expanding their teams with data scientists and AI specialists. According to a recent survey, more than half of PE firms expect to hire additional digital transformation professionals in the coming years, and roughly 51% plan to bring on more data scientists and AI experts than in previous periods.

Limited Partners Landscape Shift: Rising Influence of Retail, Retirement, and Sovereign Funds

The LP landscape is shifting rapidly as a more diverse set of investors comes into view. Growth in semiliquid structures is widening access to private market strategies. In parallel, regulators and industry bodies are placing greater scrutiny on disclosure standards, investor understanding, and protective measures.

The U.S. Department of Labor’s 2025 rescission has also opened the door for potential 401(k) access to private markets. According to the third‑quarter survey, 90% of general partners are at least “somewhat interested” in developing defined contribution products, and 24% are already working on them. Large plans are likely to pilot private‑market sleeves in target date funds, starting with private credit and tightly limited for liquidity. Record‑keepers and fiduciaries will require stronger valuation and operational disclosures, driving changes in fund design and governance.

Sovereign wealth funds (“SWF”) have increased their role and activity in private equity. In the largest buyout of 2025, SWF capital played a key role; their activity within the U.S. will continue to grow. They are now active partners and provide support for their portfolio projects in terms of strategic co-investing, as well as providing input regarding how to structure their investments to maximize the opportunity for future value creation regarding their portfolios.

Exits: IPOs Strengthen, Continuation Funds Stay Core

While there have been numerous disruptions over the last few years, the exit environment appears to be stabilising. Private equity sponsored IPO volumes reached their highest level in two plus years during Q3 of 2025, with a year-over-year increase in proceeds of 68% compared to the same time period in 2021. Bid-ask spreads have tightened, and the Federal Reserve’s announcements of two interest rate cuts projected for 2025 has provided more certainty to modelling assumptions.

Exits remain inconsistent, marked by extended holding periods and persistent valuation gaps. To manage aging portfolios, firms are increasingly relying on continuation funds and sponsor‑to‑sponsor transactions. In this landscape, strategic agility is essential. Firms must balance IPO visibility with the relative certainty of M&A and the liquidity offered by secondary markets. Continuation vehicles, innovative structures, and dual‑track processes will continue to be critical tools in 2026.

Sector Outlook: Technology, Industrial Markets, and Insurance

The resilience of the tech sector continues to stand out. With limited vulnerability to tariff swings, a rapidly escalating AI race, and a more favourable rate environment, investors remain committed to SaaS, cloud, and AI‑native platforms. The TMT sector dominates global IPO pipelines, particularly in the US. At the same time, private equity firms are gravitating toward mature, profitable tech companies that offer strong visibility after listing, signalling a clear shift from volume to quality.

Momentum is building in industrials and energy, underpinned by stable demand, domestic resilience, and the broader rise of AI. These historically traditional sectors have become foundational to digital infrastructure planning. Data centres illustrate this shift, as PE investors prioritise grid connectivity, on‑site power solutions, and long‑duration storage to support AI‑related growth. As a result, power procurement is becoming a central lever for value creation.

For credit‑focused firms, insurance is becoming a powerful strategic lever. The largest managers have already embedded insurance capabilities to help manage duration and deliver steadier returns. Others are moving in the same direction, using insurance platforms to diversify funding and build greater resilience. There is also growing momentum behind insurance‑linked vehicles as a way to reinforce credit strategies, particularly when interest‑rate conditions are more volatile.

Future Scope

These patterns highlight a sector intentionally shaping its next chapter amid increasing complexity. As technological progress and deeper specialization continue, the advantage will belong to firms that adapt quickly and innovate boldly.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2026 Small World Business Advisors LLC www.swbadvisors.com

The United States tax system does not treat U.S. branches of foreign banks as separate legal entities for tax purposes. Instead, the foreign bank itself is considered the taxpayer.

Foreign banks engaged in a trade or business in the U.S. are taxed on taxable income that is effectively connected income (“ECI”) with the conduct of that U.S. trade or business. Further, while the foreign corporation remains the taxpayer, certain provisions of the Internal Revenue Code (“IRC”) and Treasury Regulations treat U.S. branches as if they were separate entities for specific purposes.

• Reg. § 1.882-5 provides rules for determining deductible interest expense of a foreign bank by treating interest as attributable to the U.S. trade or business.

• The Branch Profits Tax (“BPT”) and Branch-Level Interest Tax (“BLIT”) impose additional taxes at the branch level.

• Most income tax treaties rely on the permanent establishment principle, allocating to the U.S. branch the profits the branch would have earned if it were an independent and separate enterprise.

This article will concentrate on selective, but central topics, such as:

• The notion/definition of ECI as it applies to foreign banks.

• The provisions of Reg. § 1.882-5 for the deduction of a foreign bank’s interest expense.

• The relationship between interest allocation under § 1.882-5, the BPT, and the BLIT.

• More general implications of such rules and provisions given the increasing complexity of cross-border banking.

Effectively Connected Income (ECI)

Effectively Connected Income – The Basics

A foreign corporation with a branch located in the United States is almost always classified as being engaged in a trade or business in the United States; therefore, such a corporation is subject to U.S. federal income tax on taxable income that is considered to be “effectively connected” with the conduct of that United States trade or business.

If the foreign corporation is eligible for treaty benefits, it is subject to U.S. taxation only to the extent that the U.S. income is “attributable” to a permanent establishment in the United States. Although “effectively connected” and “attributable” do not mean the same thing, in practice they are sufficiently similar to produce the same results, with specific exceptions noted in the review (e.g., differences with respect to the “residual force of attraction” rule in IRC § 864(c)(3)).

Foreign bank’s ECI is taxed in much the same way as income for a domestic bank. Such income is subject to the corporate tax rate (21% federal as of November, 2025) in accordance with IRC §11 and 882(a).

The “All-Or-Nothing” Rule

A key aspect of the ECI regime is the “all-or-nothing” treatment of a specific income item: the item is either completely treated as ECI or completely excluded from ECI. No pro-rata allocation is allowed between different bank branches regardless of the fact that different bank locations contributed economically to the transaction. This would mean U.S. tax could be assessed on more (or sometimes less) than the branch’s actual economic share of the income.

Interbranch Transactions Disregarded

Another basic principle is that interbranch transactions are not respected under U.S. tax law. Because a branch is part of the same legal entity, a loan or swap with a U.S. branch and its foreign home office (or another branch) is simply ignored for U.S. tax purposes. Interbranch transactions may matter for regulatory purposes or for financial reporting, or for tax purposes in some foreign jurisdictions but not for U.S. federal tax purposes.

These features create a risk of double taxation. The U.S. may tax ECI using broad, all-or-nothing attribution rules. A foreign jurisdiction may tax the same income at the same time especially if it respects interbranch dealings that the U.S. disregards.

Therefore, foreign banks must plan accordingly while also relying on treaties for cross-border transactions with U.S. counterparts.

Specific Categories of Income

1. Interest Income & Gains on Debt Securities

• Banks are governed by a special ECI rule in Reg. § 1.864-4(c)(5). This rule is available to banks if they are regulated by the U.S. and deal with determining whether or not the interest or gain on debt securities is effectively connected income.

• The core test for this purpose is as follows: A debt security is attributable to a U.S. branch if that branch actively and materially participates in the solicitation, negotiation or performance of activities necessary to acquire the security.
  • Participating in loan negotiations, credit analysis, collateral assessment or approval of terms would fall within this category.
  • A bank would not meet this participation standard through merely passive activities such as recordkeeping, clerical processing or mere signatory approvals.

• In terms of the attribution principle, once a security has been attributed to a U.S. branch at acquisition, it remains attributable to the branch during the holding period. This is referred to as the “once attributed, always attributed” rule.

Special cases:

• Typically, securities bought by the home office and later recorded in the U.S. branch are not ECI because the branch did not participate in the acquisition.

• Revenue Ruling 86-154, Situation 3, confirmed that even though the home office negotiated a global credit line, it still held that a U.S. branch loan could be appropriately attributable to such branch as long as the branch did the following:
  • Negotiated collateral;
  • Performed an independent credit analysis;
  • Funded the loan; and
  • Recorded it on the books of the branch.

This ruling confirmed that the home office, and the U.S. branch, could each participate actively and materially in the loan acquisition, making the portion attributable to the U.S. branch as ECI.

2. Dividends and Gains on Stock

• The exception to ECI rules for banks applies to certain stock, but only in certain circumstances. Stock is considered attributable to a branch (and thus generates ECI) only when:
  • It is received as additional consideration for making a loan.
  • It is pledged as collateral and later acquired through foreclosure.
  • It is acquired in the process of distributing securities to the public.

• In practice, stock holdings are rarely considered attributable to the U.S. branch unless closely associated with some loan or distribution.

• Moreover, stocks of a banking subsidiary cannot be considered attributable to the branch, and stocks of banking subsidiaries almost never generate ECI.

3. Fee Income

• Bank fee income arises in conjunction with lending franchise and advisory activities. Common examples of fee income include loan commitment fees, origination fees, servicing fees, placement fees, and financial advisory fees.

• Source rule: These fees are U.S.-source income if the services are performed in the United States.

• Treatment: Generally fees are treated as compensation for services and not interest.

• Exception: Fees can be recharacterized as interest or original issue discount if fees are unreasonable or not contingent on actual services rendered.

4. Letters of Credit and Guaranty Fees

• Commissions received on letters of credit, confirmations, acceptances, or other credit guarantees are not treated as interest but the IRS often analogizes them to interest for sourcing purposes.

• If the person whose credit is guaranteed is a U.S. person, the commission is U.S. source and ECI if the U.S. branch participated materially in issuing the guarantee.

• If the credit guarantee relates to a foreign person, the income is foreign-source and not ECI, even if the U.S. branch issued or processed the guarantee.

• Without a treaty, such fees may otherwise be subject to 30% withholding tax if classified as U.S.-source FDAP.

5. Foreign Currency Transactions, Swaps, Options, Forward Contracts, and Other Derivatives

• Contemporary international banks are directly engaged in active trading in the forex, swaps, options, forwards, and derivatives market.

• The trading model often employs many branches of the bank in a single transaction, commonly referred to as global trading.

• ECI test: Income is ECI if the U.S. branch’s business activities are a material factor in realizing the income. This is a broader test than the “active and material participation” test for securities, and, therefore, typically captures a broader range of activity as ECI.

Problem Areas

• Interbranch transactions do not receive tax recognition. A U.S. branch cannot recognize hedges or swaps with its home office.

• This creates the “split hedge problem” a U.S. branch recognizes gains from a position despite home office or another branch creating a corresponding loss and offsetting the risk.

An example: A New York branch quotes and executes a dollar interest rate swap with a U.K. customer; however, negotiations are handled by London personnel.

Result: The entire income is taxed as ECI in the U.S. despite significant involvement from London.

Consequences: These rules lead to over-inclusion of income into the U.S. tax base and the risk of double taxation since other jurisdictions will want to tax their perceived share.

Expenses and Losses of the Branch

A. Expenses and Losses Other Than Interest

Expenses that are allocable to the bank’s U.S. trade or business are factored in for determining effectively connected taxable income (ECTI). These deductions are meant to put a foreign bank’s U.S. branch on a substantially equal footing with a domestic bank to ensure that the tax base reflects the branch’s true net income.

• Personnel costs: Salaries, wages, and employee benefits for employees working at or for the U.S. branch.

• Occupancy costs: Rent, lease payments, utilities, and maintenance of office premises.

• Operating costs: Professional fees, supplies, and other general and administrative costs of the U.S. trade or business.

• Depreciation and amortization: For tangible assets (e.g., office equipment, computer systems) used in the conduct of the U.S. trade or business.

• Losses: Write-offs or other operating losses that are properly allocated to the branch’s U.S. activities.

B. Interest Expense

Dealing with interest expense is one of the least straightforward and most debated issues of taxing U.S. branches of foreign banks. Because interest expense is often the largest expense of a banking operation, the allocation or proportionality of interest expense can dramatically change the U.S. taxable income of the branch.

1. Statutory Basis : IRC § 882(c) and Treas. Reg. § 1.882-5 govern the manner in which a foreign bank calculates the amount of interest expense that is deductible against the bank’s effectively connected income (ECI). The general rule: A foreign bank may deduct a reasonable proportion of interest expense to the extent that it is properly allocable to U.S. activities.

2. Formula-Based Allocation : The regulations apply a formula method, as opposed to a direct tracing of borrowings and loans to U.S. operations:

• Step1: Calculate the ratio of U.S. assets to worldwide assets.
• Step2: Multiply this ratio by the bank’s worldwide interest expense.
• Step3: The resulting amount is treated as deductible U.S. interest expense for the branch.

Example: If a bank has $100 million of worldwide assets, $20 million of which are in the U.S., and $10 million of worldwide interest expense, the bank would allocate $2 million (20%) to the U.S. branch as deductible interest.

3. Policy Reasoning: This formula seeks to limit the occurrence of earnings stripping; that is, foreign banks attempting to over-allocate interest expense to their U.S. branch (to decrease U.S. tax income) while retaining its income abroad. It embodies a neutrality principle, in that the U.S. branches are to be taxed in the same manner as domestic banks that incur genuine funding costs in the U.S. In practice, however, the rules often stray from economic reality, as they do not track actual borrowing and lending flows.

4. Critique and Practical Challenges : The formula may seriously over-allocate or under-allocate interest compared to the true economics of the bank’s funding.

For example:

• A branch may fund itself primarily with U.S. deposits but is nonetheless forced under the formula to deduct interest on a worldwide ratios basis.
• On the contrary, if the majority of the U.S. assets were funded abroad, the formula may allocate excessive interest expense to the branch, creating an inflated deduction.

These discrepancies create uncertainty and difficulties with compliance, but they are particularly challenging for banks that have intricate cross-border structures.

5. Excess Interest and BLIT : If the allocation under Reg. § 1.882-5 results in the branch having “excess interest” (the branch is considered to have more U.S. liabilities than supported by U.S. assets), it will be subject to Branch-Level Interest Tax (BLIT) under IRC § 884. BLIT is levied at a rate of 30% on the excess interest, which is treated like a deemed dividend repatriated out of the U.S. So, interest allocation impacts more than just deductions.

The Branch Profits Tax (BPT) and Branch-Level Interest Tax (BLIT)

A. Overview

The U.S. tax system imposes additional taxes on foreign banks’ U.S. branch operations using two methods: Branch Profits Tax (BPT) and Branch-Level Interest Tax (BLIT). The relevant statute is IRC § 884, which aims to ensure that foreign banks are treated the same as U.S. subsidiaries of foreign corporations.

1. Branch Profits Tax (BPT): Branch profits tax is assessed at the rate of 30% on the “dividend equivalent amount” from a foreign corporation’s effectively connected earnings and profits (ECEP) from a U.S. trade or business not reinvested in the trade or business in the U.S. The BPT conceptually functions similar to the withholding tax that would be applied where a U.S. subsidiary of a foreign parent were to remit dividends overseas. The calculation follows the steps below.

• Step1: Effectively connected taxable income (ECTI).
• Step2: Adjust for increases and decreases (positive and negative) in the branch’s net equity in the U.S.
• Step3: The amount that is not reinvested (ECEP less reinvestment) is the dividend equivalent amount subject to the 30% BPT tax.

Taxing BPT serves to disincentivize foreign banks from treating income from U.S. branch profits as tax-free repatriations to the home office.

2. Branch-Level Interest Tax (BLIT) : The BLIT is applied to excess interest that is regarded as paid by the U.S. branch to either its affiliated lenders or its foreign home office. Excess interest comes into play under the interest allocation regulations found in Reg. § 1.882-5, when the branch’s allocable liabilities (hence deemed interest expense) exceed its U.S. assets. This excess interest is treated as if it was interest paid to parties outside the United States and is subject to a 30% tax (or a treaty rate, if applicable). The BLIT is designed to deter foreign banks from avoiding withholding tax simply by shifting funding structures into and through their branch offices.

3. Policy Rationale : Both the BPT and BLIT were enacted to provide parity between U.S. branches of foreign banks and U.S. subsidiaries of foreign entities.

• Absent the BPT and BLIT, a U.S. branch could effectively remit profits or interest back to their home office without any withholding requirements.
• These tax regimes ensure that branch operations do not create a loophole to avoid withholding tax.

B. Coordination of the BPT, BLIT, and Interest Allocation Rules

The functioning of the branch profits tax (BPT) and the branch-level interest tax (BLIT) is closely tied to the interest allocation rules at Reg. § 1.882-5. The tax provisions operate based on the concepts of branch equity, branch liabilities, and deductible interest. This overlap of concepts can create complex, and at times, adverse, situations for foreign banks.

Interconnecting Mechanisms: Net equity impact: The BPT operates based on an increase in a branch’s U.S. net equity. If the interest allocation rules attribute unjustifiable U.S. branch liabilities, that leads to a decrease in the branch’s U.S. net equity. A lower level of U.S. net equity increases the dividend equivalent amount and, correspondingly, the Branch Profits Tax (BPT). Excess interest impact, while that occurs, the excess U.S. branch liabilities can create excess interest in the allocation rules.

In turn, the BLIT leads to an additional tax of 30% on any excess interest deemed to have been paid outside of the U.S. In short, one imbalance from the allocation rules can create an increase in both BPT and BLIT taxes.

Concluding Remarks

The U.S. tax regime for foreign bank branches can be viewed as still disordered, outdated and ill-suited for the modern environment of banking around the world. The Code and regulations intend to equalize the treatment of foreign bank branches with domestic banks, but the regulations often do not fulfill this goal.

Disorder and Risk of Double Taxation

The rules governing effectively connected income, allocating expenses (typical of interest), and the branch profits tax and branch-level interest tax do not provide consistent and logical interaction.

Although interbranch transactions are disregarded, branch equity and liabilities are incorporated into the BPT and BLIT rules, so banks can be expected to pay tax on amounts that may not reflect their underlying economic income.

As a result, income is frequently over-included in the U.S. tax base which often results in double taxation when foreign jurisdictions assert taxing rights.

Disconnect with Global Banking Activity

These rules were promulgated long before modern global trading, derivatives activity and complex financial products existed. The all-or-nothing attribution rules ignore that branches often combine to create a single transaction. The forced exclusion of interbranch transactions (e.g. loans, swaps, hedges) creates a serious distortion since those transactions tend, at a minimum, to receive respect under regulatory purposes, accounting purposes and foreign tax purposes.

Areas Requiring Reform

• Reforms should provide recognition of the economic substance of dealings between a U.S. branch and its foreign home office or other branches.
• Any reforms must utilize ECI rules, interest allocation, and branch-level taxes (BPT/BLIT) in a coherent way, such that the same structural choices should not give rise to multiple overlapping taxes.
• Reforms must provide clearer and more fair rules for global trading operations that align taxation with the true contribution of each branch.

Interim Measures

Until there are reforms enacted, Advance Pricing Agreements (APAs) provide a practical, though imperfect, way to lessen exposure. Borrowing transfer pricing methodologies under IRC § 482 for interbranch allocations might assist inter-branch allocations for the U.S. to align with economic substance. Although these efforts help alleviate the current risk, the suggested stop-gap solutions are not proper substitutes for systemic reform, and could likely lead to greater inconsistency if some taxpayers use a “private law” path.

If no significant reforms are adopted, the tax rules governing foreign bank branches will continue to lead to outcomes that may be both inequitable and economically distorted, thus placing significant compliance costs on banks and risking inappropriate double taxation. Finding a way to tax foreign branches in line with the realities of global business is important both to promote fairness and to promote the integrity of the U.S. tax system.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com

Each year, the IRS publishes inflation adjustments to a number of tax provisions to reflect the rising costs. For tax year 2026, the inflation adjustments are especially noteworthy because of certain amendments in the One Big Beautiful Bill Act (“OBBBA”). The amendments affect standard deductions, income tax marginal tax brackets, estate and gift tax exclusion amounts, some of the employer benefits credits, and more. It is vital for business leaders, advisors, and taxpayers to be aware of benefit of these provisions and changes.

Key Adjustments for Tax Year 2026

1. Standard Deduction Increases

• Married-Joint: $32,200 (up from $31,500)
• Single / Married-Separately: $16,100
• Head of Household: $24,150
• The increases provide some minor relief and accounts for inflationary pressure.

2. Marginal Tax Bracket Updates

• Top rate of 37% continues for incomes over $640,600 (single) and $768,700 (married-joint).
• Other brackets (35%, 32%, 24%, 22%, 12%, and 10% rates) are raised, which reduces “bracket creep.”
• The minimum tax rate is 10% for single filers with an income of $12,400 or less ($24,800 for married joint filers).

3. Alternative Minimum Tax (AMT) & Exemptions

• AMT exemption for unmarried individuals is $90,100 (phasing out at 500,000).
• For Married Filing Jointly, the phase out threshold is $1,000,000.

4. Estate & Gift Tax Exclusions

• The basic estate tax exclusion amount increased to $15,000,000 (up from $13,990,000).
• Annual gift exclusion remains $19,000 and the special exclusion for non-citizen spouses increases to $194,000.

5. Adoption Credits

• The maximum credit permitted for adoptions for the tax year 2026 is the adoption-related qualified expenses up to $17,670 which is an increase from $17,280 for 2025.
• For tax year 2026, the maximum refundable credit is $5,120.

6. Employer-Provided Childcare Tax Credit Boost

• OBBB significantly enhanced this:
• The cap for the childcare credit increased from $150,000 to $500,000 ($600,000 for eligible small business).

7. Other Adjusted Items

• Earned Income Tax Credit (EITC) maximum for qualifying taxpayers is now $8,231.
• Qualified Transportation Fringe Benefit/parking limit is now $340/month.
• Health Flexible Spending Arrangements (FSAs): salary reduction limit is now $3,400 and carryover limit is $680.
• Medical Savings Accounts: deductible/out-of-pocket limits adjustments.
• Foreign Earned Income Exclusion is now $132,900 (up from $130,000).

Implications & Takeaways for Businesses & Founders

• These inflation adjustments help mitigate tax drag created from rising nominal income, but do not affect the core tax structure.
• High net worth or pass-through entities will be more relieved with an increased exemption from estate and gift tax limits for planning and legacy purposes.
• The increased employer childcare credit could specifically help businesses that already offer generous benefits.
• Higher exemption thresholds (AMT, standard deduction) eliminated moving taxpayers into higher marginal burdens.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com

Federal legislation enacted on July 4, 2025, has expanded the gain exclusion available for sales of qualified small business stock (QSBS) under Section 1202. The revised law increases tax savings for shareholders in eligible domestic corporations, and government estimates show that taxpayer savings will rise by approximately $4.5 billion each year once all changes are in effect. This update marks the most significant change to Section 1202 since the exclusion was increased to 100% in 2010. The new provisions only apply to QSBS issued after July 4, 2025. Stock issued before this date remains governed by the previous rules.

Recent Amendments to Section 1202 Provisions

The recent legislation introduces three fundamental changes aimed at broadening the accessibility and enhancing the value of qualified small business stock (QSBS) under Section 1202:

• Revised Holding Period Requirements for Gain Exclusion: The rigid five-year requirement has been replaced with a phased exclusion system. Investors now receive 50% gain exclusion after three years, 75% after four years, and 100% after five years. This eliminates the previous cliff effect that created market distortions and provides immediate incentives for patient capital.
• Increased Maximum Exclusion Limit: Prior to recent legislative changes, Section 1202 provided a gain exclusion capped at the greater of $10 million or ten times the taxpayer’s adjusted stock basis. This $10 million minimum limit was established in 1993 and has remained fixed since then, without any inflation adjustments. The One Big Beautiful Bill Act (OBBBA) increases this exclusion floor to $15 million for stock issued after July 4, 2025. Additionally, it introduces annual inflation adjustments starting in 2026 to maintain the exclusion’s real value over time. As a result, eligible taxpayers, including individuals, estates, and trusts, can now exclude at least $15 million of taxable gains from QSBS sales. The provision’s multiplier factor of ten times the stock basis, however, remains unchanged under this update.
• Expanded Gross Asset Limits: Qualifying small businesses can now maintain up to $75 million in aggregate gross assets, up from $50 million. Combined with ongoing inflation adjustments, this expansion significantly increases the pool of eligible companies and extends qualification windows for growing enterprises.

These enhancements apply exclusively to stock issued after July 4, 2025, creating distinct treatment between existing holdings and new issuances.

Implications of OBBB Revisions on Investors and Corporations

The One Big Beautiful Bill Act (OBBBA) introduces important changes to Section 1202, increasing the tax advantages available to investors and the companies in which they invest through qualified small business stock (QSBS).

• Restored Eligibility for Corporations Under Revised Asset Thresholds: Corporations that once exceeded the previous $50 million gross asset limit but now fall below the updated $75 million cap may become eligible once again to issue qualified small business stock (QSBS). These companies should assess the potential impact of this change on their financing and exit strategies. Furthermore, investors who may not meet the newly introduced three to five year holding period requirement might still benefit, as increases in the 10-times basis exclusion can enhance the amount of tax-exempt gain associated with recently issued stock.
• Extended Qualification Periods for Corporations: Several OBBBA provisions tend to reduce the tax basis of corporate assets, which directly affects eligibility for QSBS issuance because the asset thresholds are measured on a tax basis. Key provisions include full bonus depreciation, expanded Section 179 deductions, the ability to expense certain qualified manufacturing real estate, and renewed deductibility for domestic research expenses. Together, these can prolong a corporation’s ability to meet QSBS requirements.
• Increased Accessibility for Later-Stage Investors: Previously, investors involved in later stage funding faced challenges in qualifying for QSBS gain exclusions due to the strict five year holding requirement and asset limitations. The new phased gain exclusion, permitting a 50% exclusion after three years, coupled with the increased gross asset ceiling of $75 million (subject to inflation adjustments), significantly reduces these barriers. This update supports companies that pursue multi-round growth strategies by providing more accessible tax incentives to a wider range of investors.
• Refreshing Previously Issued Stock Under New QSBS Rules: Under the updated regulations, stock issued previously generally cannot be reclassified to benefit from the revised Section 1202 rules if it originally qualified only under the older standards such as the $10 million gain exclusion cap and the five year holding period or if it did not qualify as QSBS at all. However, an exception may exist for corporations recently formed with initial assets exceeding the previous $50 million threshold. Such entities might consider a taxable liquidation followed by reincorporation to issue new stock that satisfies the updated QSBS qualifications. This approach is most effective when the business has experienced limited appreciation since its formation and requires careful structuring to ensure compliance and intended tax outcomes.
• Incorporating a Partnership to Access Section 1202 Benefits: Converting a partnership into a C corporation can offer considerable tax advantages under Section 1202. With the recent increase in the gross asset threshold to $75 million and the implementation of a shorter three year holding period, this conversion option becomes more appealing than before. These changes expand eligibility, allowing a greater number of partnerships to take advantage of the tax benefits available through qualified small business stock (QSBS).

Strategic Planning for S Corporations

Direct Conversion Limitations

Simply revoking S election provides minimal benefits since existing S corporation stock cannot qualify as QSBS retroactively. This approach only benefits future stock issuances, making it generally inadvisable without additional restructuring. Similarly, merging an S corporation into a C corporation fails to create QSBS treatment for exchanged stock. Federal court decisions confirm that stock for stock exchanges disqualify QSBS treatment under Section 1202(c)(1)(B).

Advanced Restructuring Solutions

• Asset Dropdown Strategy: S corporations can transfer operating assets to newly formed C corporation subsidiaries. The parent S corporation holds qualifying stock in the subsidiary, allowing QSBS gain exclusions to flow through to shareholders upon disposition. This approach preserves existing ownership structures while positioning future appreciation for QSBS treatment. Only post contribution appreciation qualifies for exclusion benefits.
• F Reorganization Alternative: Shareholders contribute S corporation stock to a new holding company, which elects qualified subchapter S subsidiary (QSUB) status for the original entity. After converting the QSUB to a disregarded LLC, the holding company contributes business assets to a new C corporation subsidiary. This structure offers two key advantages: no asset title transfers required and potential retention of the original employer identification number.
• Section 269 Compliance: Both strategies require careful analysis of anti-avoidance provisions. While Section 1202 represents deliberate congressional incentive, taxpayers must demonstrate legitimate business purposes beyond tax reduction.

Risk Management Considerations

• Step Transaction Doctrine: The F reorganization approach faces potential IRS challenge under liquidation reincorporation principles if transactions appear orchestrated solely for tax benefits.
• Divisive Merger Alternative: In jurisdictions with divisive merger statutes (Texas, Delaware), S corporations can split assets into separate entities through statutory merger, achieving similar results with reduced step-transaction risk.

Investment and Corporate Opportunities

• Later-Stage Investment Accessibility: The combination of reduced holding periods and expanded asset limits removes traditional barriers facing later round investors. Growth equity and private equity funds can now meaningfully incorporate QSBS benefits into investment strategies.
• Partnership Conversion Benefits: The expanded framework makes C corporation conversion increasingly attractive for partnerships and LLCs. The higher asset threshold accommodates larger enterprises while the three year holding period reduces timing pressures for partners.
• Requalification Potential: Companies that previously exceeded the $50 million asset threshold but remain below $75 million can issue fresh QSBS. This creates immediate planning opportunities for Growth-stage companies approaching traditional size limits, buy-and-build strategies seeking investor attraction and portfolio companies considering recapitalization events
• Stock Refresh Strategies: While existing stock generally cannot benefit from new rules, specific fact patterns may support taxable liquidation followed by reincorporation. This approach works best for recently formed companies with limited appreciation since original formation.

Implementation Best Practices

• Timing Considerations: All enhanced benefits apply only to stock issued after July 4, 2025. Existing stockholders should evaluate whether restructuring creates new qualifying issuances while managing potential tax consequences.
• Documentation Requirements: The graduated exclusion system creates tracking complexity across multiple stock tranches with different acquisition dates and applicable exclusion percentages. Robust documentation systems become essential for compliance and optimization.
• State Tax Coordination: QSBS benefits apply exclusively for federal purposes. State tax implications of restructuring and ongoing operations require separate analysis, particularly in high tax jurisdictions lacking federal conformity.

Actionable Planning Steps

Tax professionals should immediately assess client situations for QSBS optimization:

• Portfolio Assessment: Review existing investments for restructuring potential under expanded thresholds and reduced holding periods.
• Entity Analysis: Evaluate S corporations and partnerships for conversion opportunities, weighing QSBS benefits against other tax considerations including state implications.
• Investment Integration: Incorporate QSBS considerations into due diligence for new investments, particularly those approaching expanded asset thresholds.
• Systems Enhancement: Implement tracking capabilities for complex holding period and exclusion percentage requirements across multiple stock issuances.

Conclusion

The expanded QSBS framework creates generational wealth building opportunities through sophisticated tax planning. Success requires balancing immediate benefits with long term strategic objectives while maintaining strict regulatory compliance.

Professional advisors who master these provisions will deliver substantial client value while positioning practices at the forefront of advanced tax planning in the evolving regulatory landscape.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com

The federal government shutdown, initiated on October 1, 2025, resulted from a legislative impasse in Congress over the approval of budget appropriations for the 2026 fiscal year. Despite extensive negotiations, Congress was unable to enact the necessary funding legislation to maintain full government operations. Adding complexity to this deadlock is the executive branch’s selective withholding of funds previously authorized by Congress, creating significant uncertainty around the timely distribution and utilization of appropriated resources across federal agencies. This withholding has generated legal challenges concerning the scope of executive authority in managing congressional appropriations, with a definitive resolution pending before the Supreme Court. 
 
While political in nature, the consequences extend far beyond government corridors, affecting businesses, taxpayers, and community organizations. Agencies dependent on federal approvals, grants, or data often face immediate operational disruptions, making proactive planning essential. 

Impact on Taxpayers and Businesses

Even during a shutdown, the Internal Revenue Service continues to collect taxes. However, its responsiveness can be significantly reduced. Refund processing, audit resolutions, and taxpayer assistance services may experience delays, and credit applications or access to financial verifications dependent on IRS data can be affected. 

Electronic systems may remain operational, but limited staffing can slow the processing of amended returns and correspondence. Taxpayers should anticipate extended timelines for notices, rulings, and other communications. For businesses, delays in approvals, audits, and regulatory guidance can impact financial reporting and operational decisions. 

Challenges for Not-for-Profits and Community Organizations 

Nonprofits face unique challenges during a shutdown. Many rely on federal grants and contracts to sustain critical programs. Delays in payments or approvals can strain cash flow and complicate operational planning. Pending grant renewals or new applications that require federal sign-offs may be postponed, while the demand for community services often rises in times of economic uncertainty. 

Board oversight and governance play a critical role in navigating this period. Leadership teams must stay informed about funding disruptions, program adjustments, and compliance obligations to maintain organizational stability. Transparent communication with donors and funding partners is essential to preserve trust and demonstrate sound stewardship of resources. 

Operational and Compliance Disruptions 

Shutdowns can disrupt administrative and compliance processes for both nonprofits and private sector entities. Tax-exempt status filings, grant approvals, and federal contract payments may be delayed or suspended. Limited access to federal databases and guidance can slow financial reporting and decision-making. 

Documenting these interruptions is crucial for compliance and potential relief considerations. Organizations should ensure restricted funds are used appropriately and maintain records to demonstrate adherence to regulatory and contractual obligations. 

Financial Management During a Shutdown 

Proactive financial planning is essential. Organizations should assess liquidity and maintain cash reserves sufficient to cover 60 to 90 days of essential operations, including payroll and vendor obligations. Reviewing budgets, prioritizing mission-critical activities, and identifying opportunities to defer non-essential projects can help preserve operational capacity. 

Diversifying revenue streams beyond federal sources reduces reliance on government funding and enhances resilience. Maintaining clear communication with stakeholders, including donors and funding agencies, supports confidence and helps mitigate uncertainty. 

Building Resilience for the Future 

The length and impact of government shutdowns are unpredictable. Organizations that prepare strategically are better positioned to manage disruptions without compromising long-term objectives. Updated contingency plans, flexible operational structures, and transparent communication form the foundation for navigating uncertainty. 

Shutdowns also present opportunities to strengthen governance, reassess funding strategies, and enhance financial reserves. By combining prudent financial stewardship with adaptive operational planning, organizations can maintain stability and continue delivering on their mission, even during periods of disruption. 

Summary

Understanding the operational, financial, and compliance implications of a government shutdown allows organizations to act proactively. With foresight and disciplined planning, both taxpayers and nonprofit entities can minimize disruption and maintain confidence with stakeholders.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com

The private equity landscape has reached a critical time period in 2025. Following numerous years of exponential growth rates, dealmakers now experience a very different reality of longer hold periods, tighter liquidity, and changing investor expectations. Many portfolio companies are now being held far beyond when they were originally expected to exit, creating additional pressure from limited partners (LPs) to expedite capital distribution back to investors. Simultaneously, capital formation cycles are lengthening as LPs become more strategic and selective with investments and dealmakers demonstrate capital discipline and efficient capital distributions.

This landscape presents a broader challenge for CFOs, deal teams, and LPs as they strive to navigate a complex scenario, reconciling the near-term focus of monetizing value versus the long-term focus of creating sustainable value. And to add to the complexity, the evolving tax reform (think One Big Beautiful Bill Act (OBBBA)), increased scrutiny on management’s compliance with regulations, and demands for better valuation transparency are all increasing the scrutiny on dealmakers.

This edition of TaxJourney® highlights deal-making trends that continue to shape U.S. private equity in 2025. From holding periods to liquidity considerations, this edition uncovers realities that can help navigate today’s reality while presenting tomorrow’s opportunities.

Deal Activity & Exit Environment

The recovery in private equity dealmaking has not progressed consistently in the first half of 2025. Transaction volume overall is subdued, and firms are still grappling with valuation gaps, high interest rates, and low availability of credit. Most managers have still withheld capital deployment pending clearer pricing and macroeconomic stability.

However, within this relatively flat landscape, exits ramped up in selected segments. In the first half of 2025, industry data shows firms announced 215 large exit transaction, a total value of $308 billion, representing the strongest mid-year proceeds in three years. Strategic buyers were the leaders in supporting these transactions, while IPO activity was muted, and results dwindled due to declining secondary buyouts (-9%) year-over-year. These selective exits show assets with reasonable preparedness and quality can still receive competitive bidder attention despite wider pressures.

One of the key trends is the lengthening of holding periods. Data shows that 35% of portfolio assets have now been held in excess of six years, which has led to substantial NAV being tied up and growing concerns by LPs regarding liquidity levels. With the mounting pressure, many firms are moving in the direction of more flexible valuations: 40% of managers indicated they would accept 5-10% discounts against their original underwriting in order to release liquidity; another 24% indicated they would accept larger haircuts between 10-20%.

In turn, market data shows firms are focusing on being exit ready much earlier in the cycle. 93% of private equity professionals indicate that being prepared to exit prior to the sale process will maximize valuations. Almost half of all professionals now begin their exit planning 12-24 months prior to sale, as being aligned around tax implications, buyer positioning, and valuation strategy much earlier in the sale process is an emerging competitive differentiator for deal teams.

Implication:

Although aggregate deal volumes continue to remain low, controlled exits are creating opportunities for value creation as well as liquidity. Managers, who are able to exit portfolios sooner rather than later and manage investor expectations while still applying discipline to exit processes, will be best positioned to return cash to LPs and maintain investor confidence during challenging times.

Liquidity & NAV Pressure

The dilemma of trapped capital versus investor liquidity is defining the landscape for private equity in 2025, as there remain a large percentage of net asset value (NAV) trapped in aged vintage funds; over 30,000 assets are waiting to be monetized. More than 35% have been held for over 6 years, which is much longer than intended by the original investment process. This creates a challenge for managers in recycling capital for new investments.

Limited partners (LPs) are moving away from traditional measures (i.e. internal rate of return (IRR)), and instead, are increasingly focused on distributions to paid-in capital (DPI). While IRR remains an important metric especially for mid to late cycle funds, the current situation is more about realized cash. In fact, 40% of GPs said they would accept a 5 to 10% discount to their original underwriting for immediate liquidity, and a further 24% said they would agree to a bigger discount of 10 to 20% to get distributions to their LPs.

Fund managers are turning to creative liquidity solutions such as GP-led continuation funds, secondary sales, and structured deals. These approaches provide partial distributions to LPs while preserving long-term ownership of high-quality assets, avoiding forced liquidations at weak valuations.

Implication:

Liquidity planning has become a strategy. Firms that can balance prolonged holding periods with innovative solutions will not only ease LP pressure, but will also become pressure tested in a capital formation constrained environment.

Fundraising Environment

Fundraising has become one of the top concerns for private equity managers in 2025. With fewer exits and delayed distributions, limited partners are pressing harder for realized returns before committing fresh capital. The result is a fundraising cycle that is more selective and far more competitive.

Recently published figures from the market demonstrate that closed fund values are nearly $223 billion for the first half of 2025 and are projected to be down 20% this year. Large funds continue to dominate inflows while mid-market and emerging managers face more challenges.

LPs also are conducting more oversight and favoring those firms with real experience, operational resiliency, and cash distributions (DPI) as opposed to just paper returns (IRR). This reinforces the importance of managing liquidity as a differentiator in fundraising.

Looking forward, fundraising conditions are likely to be tight until late 2025, and the pace of exits and realizations will be an important leading indicator for capital formation in 2026.

Dynamics of the Secondary Market

The secondary market has emerged as an important outlet for liquidity concerns within the private equity universe. GP-led funds continue to grow in popularity allowing for a mechanism for managers to continue owning quality portfolio companies while providing partial cash returns to their LPs as well. It is representative of a realignment of the exit strategy, firms are less often forced to sell as exits are more muted in the M&A space, and are leveraging continuation vehicles to maintain their value and optionality.

Similarly, secondaries are becoming a more traditional alternative to IPOs and traditional trades. A secondary allows one PE fund to sell its stake in a company to another PE fund, providing liquidity for the selling fund while maintaining an asset that continues to be part of the an ecosystem of private equity.

The market is not only increasing in use but also in scale. 2024 was an all-time high for secondaries fundraising at over $90 billion raised and just for H1 of 2025, there has been another $60 billion since then, without factoring full 2025 data, and we are already on track to surpass previous highs in 2025. However, despite all the record fundraising, the market is still described as undercapitalized expeditious deal flow continues to outpace capital. Roughly half of H1 2025 fund inflows were in one large fund is indicative of considerable supply and demand imbalance present in Fundraising Markets.

All of these developments combined are changing the expectation of capital in the industry. For investors, secondaries mean more creative exit pathways; for fund managers, they provide the tools to balance portfolio management while meeting LP expectations for distributions.

Sector & Geographic Trends

Private equity deal activity is experiencing significant sector divergence in 2025 instead of being evenly distributed. Technology and healthcare, for example, continue to garner strong investor interest, as a result of structural growth drivers like digital adoption, AI-enabled efficiencies, and demand resiliency in healthcare. In contrast, the industrials and consumer-facing sectors are lagging due to slower demand growth, higher input costs and more conservative consumer spending.

Geographic allocation trends are also illustrating this divergence. For instance, according to market data UK institutions are currently allocating an average of 7% to private equity assets while Nordic investors are allocating closer to 12%. Among the Nordics, Finland’s insurers are still allocating to tech, while Denmark’s banks and pensions are allocating to healthcare, co-investments, and secondaries. Sweden’s sovereign investors are holding firm, but leaning toward ESG and GP-led secondaries, while Norway’s sovereign wealth fund has largely stepped away from private equity. Macroeconomic risks are compounding these divergences. Existing tariff disputes, trade friction, and inflationary pressures are burdening supply chains and increasing volatility in valuations.

Takeaways for PE CFOs & Deal Teams

The private equity environment in 2025 is forcing CFOs, deal teams, and fund managers to revisit the leading fundamentals of portfolio and transaction management. Preparation, liquidity planning, and tightening-up the fundraising narrative as the new metrics for success.

• Plan Exits Early – Exit preparation can no longer just be a last minute exercise. Firms should commence war-gaming in a 12 to 24 month cycle to line up earlier on valuations, buyer positioning and any potential tax triggers. Early planning mitigates the risk of execution and enhances the ability to characterize flexibility when the markets clear.
• Focus on Liquidity Tools – With a large amount of NAV remaining trapped in older vintages, CFOs should take advantage of continuation funds and secondary sales and other imaginative liquidity paths to create distributions without distress exits. Modeling distributions strategically will position CFOs to meet portfolio time horizons of liquidity and expectations of LPs.
• Balance IRR vs DPI – LPs are placing a heightened emphasis on the tangible cash returns (DPI) versus the paper returns (IRR). This can cause CFOs to remain focused on strategy in the near term versus in the longer time. It is also advisable to communicate distribution options with LPs.
• Adapt Fundraising Conversations – As mentioned before, fundraising in a capital-rich market, focus on the differentiation. While its practically impossible for mid-tier and smaller firms to compete with larger firms dominating the fundraising process, distinguishing any operational finesse, specialization or intellectual capital; historical investment drawdowns; and advanced approaches to tax efficient planning should create the impression of separation.
• Observe Macro Risks – Unresolved geopolitical risk, tariff regimes, and tax reform measures in the U.S. like OBBBA complicate deal structuring. CFOs should incorporate scenario modelling and stress testing into their planning for greater robustness.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com

Cross-border M&A remains a significant growth area for U.S. based businesses, providing market, technology, and capital opportunities. However, the tax consequences of cross-border transactions have become significantly complicated due to multiple jurisdictions, evolving treaty interpretations, and overlapping or even contradictory compliance requirements, which pose increased challenges for deal teams and CFOs.

TaxJourney® offers a U.S. focused framework to help dealmakers, tax professionals, and investors navigate cross-border M&A tax complexities. This edition covers key issues like withholding mismatches, treaty documentation, FTC planning, and state compliance, providing strategic insights to structure deals and mitigate risk.

• Cross-Border Growth – Expanding into new markets requires careful tax planning.
• Treaty Benefits – Tax treaties can reduce or eliminate double taxation.
• Foreign Tax Credits – Proper use of FTCs lowers effective tax exposure.
• Compliance – Multi-jurisdictional reporting demands robust systems.
• Risk Mitigation – Anticipating risks protects value and smooths integration.

Cross-Border M&A Tax Complexity – Current Challenges?

Cross-border M&A provides new avenues for growth, but the IRS has made negative changes that have a large impact on deal structuring. Companies and deal teams also face various challenges, including:

• Increasing Compliance Complexity for Multi-Jurisdictional Deals – With every foreign jurisdiction involved in the cross-border transition comes its own reported standards, filing requirements, and tax laws, all of which need to be sorted through at the same time, putting massive pressure on compliance teams.

• Debated Tax Regimes, Tax Treaty Related Claims & Reporting Obligations – Tax treaties are agreements between jurisdictions to minimize double taxation. However, it still may be challenging to properly interpret the tax treaties or to properly apply the treaty benefits. Generally speaking, dealing with tax treaties will often have inadvertent consequences for our clients that may unnecessarily expose them to more tax than was originally intended, while at the same time extending the closing timeline.

• IRS Increasingly Watching Certain Cross-Border Tax Transaction Structures – With the IRS expanding their watching eyes on cross-border transactions, they are not only focused on related party transfers pricing but also on foreign tax credits, and treaty-based positions. The best deal teams can do is max out their documentation and maintain it in a defensible structure to avoid operational challenges or disputes or penalties.

Key Compliance Pillars

Robust U.S. tax knowledge is essential to the viability of cross-border M&A. Four fundamental pillars have significant implications for deal planning and execution:

• Permanent Establishment (PE) Rules – Understanding the PE rules and when a U.S. taxing jurisdiction may emerge from business being conducted, U.S. taxpayers often do not scrutinize the foreign activity sufficiently to detect that they have created a PE, and vice versa for foreign taxpayers tax, authorities, will promote optimal structuring during deal capture and allow for the mitigation of best tax practice for the target.

• Foreign Tax Credits (FTC) – The appropriate claim of FTC is necessary for any company or MNE to mitigate double taxation in the U.S. by claims for foreign tax paid. Optimal handling of the FTC calculation during deal planning will lead to improved valuation modelling and potentially assist in negotiations.

• GILTI and BEAT Exposure – For a U.S. MNE, GILTI and BEAT have a very significant influence on outbound and inbound M&A structuring. Deciding on deal structuring at the front end to ensure certainty and to minimize unintended tax leakage is essential to deal success.

• Treaty Interpretation to Optimize Tax Performance – U.S. tax treaties provide scope to mitigate withholding tax, seek treaty benefits, and optimize tax efficiency of deals. Successful application of treaty provisions require making sure that appropriate supporting documentation is progressed, and due diligence becomes crucial.

Navigating Cross-Border Deal Tax Challenges

Cross-border M&A deals require multiple tax systems to be effectively addressed and, oftentimes, even minor blunders can result in unanticipated liabilities, extended deal timelines, and/or a shrinking deal value. Two of the paramount areas to plan around are jurisdictional differences in tax and treaty-based planning.

Jurisdictional Differences

Tax rules vary greatly across countries, with the failure to reconcile jurisdictional tax rules potentially affecting the results of the transaction as follows:

• Withholding Taxes on Cross-Border Payments – Dividends, interest, and royalties paid between jurisdictions are often subject to withholding taxes. Erroneously applying treaty rates or planning for these obligations can increase overall tax cost and reduce after tax returns on the deal.
• Capital Gains Tax Variation – Variety in capital gains taxes applied in different jurisdictions exists based on different rates and different events being taxable. Without a coordinated plan there’s a risk the buyer or seller have unexpected exposure that has an impact on the negotiations and price of the deal.
• Foreign Exchange (FX) Impacts – Currency fluctuations and foreign exchange (FX) gain or loss tax treatment can complicate valuation models. Advance planning can help protect the economics of the deal and maintain forecasts.
• Transfer Pricing Rules across Jurisdictions – Arm’s length prices must be established for cross-border transactions. Transfer pricing policies are regularly applied inconsistently resulting in scrutiny, audits, and dual taxation unless they are carefully aligned with local and U.S. requirements.

Jurisdictional Factor	Risk / Challenge	Impact on Deal
Withholding Taxes	Incorrect treaty application	Higher tax costs & reduced after-tax returns
Capital Gains Variation	Different rates & taxable events	Unexpected exposure affects pricing & negotiations
FX Impacts	Currency fluctuations & tax treatment	Distorted valuations & unreliable forecasts
Transfer Pricing	Misaligned policies	Audits, disputes & potential double taxation

Treaty Considerations

Tax treaties are essential to alleviating cross-border tax burdens, but they are not always simple to use, especially on the fly as part of a multi jurisdictional deal:

Why Treaties and Taxes Matter?

U.S. tax treaties are a valuable feature that will often lower withholding rates, remove double taxation and offer some specific relief from taxation relating to the cross-border transactions. Structuring deals with efficient tax treaty treatments in mind will often lead to much increased cash flows and returns once the deal is completed.

Why You Should Prepare Documentation?

To get treaty benefits, you need documentation IRS Form W-8BEN/E or residency certificates. Any missing or misfiled documentation could lead to denied relief, unwanted leakage of tax, could lead to denied relief and unwanted tax leakage.

Leveraging Tax Treaties in Cross-Border M&A

Efficient treaty planning unlocks tax savings and maximizes deal returns.

Why Treaties Matter?

• U.S. tax treaties can lower withholding rates.
• Prevent double taxation across jurisdictions.
• Enable smoother cross-border deal structuring.
• Drive higher cash flows and post-deal returns.

Why Documentation Matters?

• Submit IRS Form W-8BEN/E or residency certificates to claim treaty benefits.
• Missing or misfiled documents can deny treaty relief.
• Documentation gaps can cause unexpected tax leakage.
• Proper filing prevents disputes and delays in deal closings.

Proactive treaty planning + accurate documentation = smoother closings and optimized tax outcomes.

M&A Structuring Considerations

A good framework for cross-border M&A deals is imperative to minimizing tax exposure, maximizing value post-deal and is subject to some situation, which may comprise citizenship or residence of the parties in the deal, relevant tax treaties, and overall business plan considerations.

Outbound vs Inbound Tax Implications

Tax implications of cross-border deals are quite different, depending on whether the deal is inbound or outbound deal.

Inbound Transactions (Foreign acquirors purchasing U.S. companies):

The specific focus areas in this kind of transaction will be, withholding taxes, treaties application, IRS Form 5472 reporting requirements on foreign-owned U.S. entities. Additionally, the buyers will need to look at exposures at the state and local level, which might not reflect federal treatment.

Outbound Transactions (U.S. buyers purchasing foreign companies):

The emphasis usually tends to be on foreign tax credits (FTC), local taxation management, and repatriation of profit from abroad earned. In cross-border deals outbound, it is necessary to appreciate GILTI and BEAT exposure, U.S. acquiror considerations.

Key Takeaway:

Cross-border M&A deals structuring involves balancing the U.S. federal jurisdiction rules, a foreign jurisdictions taxation, and any application of treaty relief to achieve the maximum tax efficiency for the two parties involved.

Strategic Vehicle Selection

Selecting the right vehicle will determine the tax result and compliance requirements extensively:

• Subsidiaries – A preferred method when assessing tax treaties and limiting liability. Accessing preferential withholding tax rates under U.S. or foreign tax treaty agreements.
• Branches – Easier to establish a branch, but direct exposure to foreign tax may arise. Often if operational presence is needed immediately in a target country.
• Hybrid Entities – Hybrid entities are structured to allow for regulatory tax flexibility, allowing companies to take reporting deductions, withholding minimizations, or dual treatment for income tax in other jurisdictions. Hybrid entities are effective when you’re aligning U.S. tax and foreign tax in the combined tax reporting.

Key Takeaway:

The best vehicle will depend on the transaction, country of transaction, and the long term operational plan. Planning your tax early will allow you to ensure the structure is conducive to compliance and operational effectiveness and efficiency in cost containment.

Choosing the Right Vehicle for Cross-Border M&A

Strategic Vehicle Selection: Impacts tax outcomes, and operational efficiency

Subsidiaries:

• Preferred for treaty benefits
• Reduces liability exposure

Branches

• Quick to establish, faster market entry
• Direct exposure to foreign taxes

Hybrid Entities

• Offers tax flexibility across jurisdictions
• Allows dual tax treatment benefits

Key Takeaway:

The optimal structure depends on the transaction type, jurisdiction, and long term operational strategy. Early planning ensures compliance and cost efficiency.

Practical Steps – Checklist for Deal Teams

To execute an effective cross-border M&A transaction, a systematic, phased approach is essential. Each phase of the transaction contains tax implications and integrated across each phase will influence value and compliance.

Pre-Deal Phase

The groundwork for a successful crossing-border deal is laid before deal negotiations commence. Proactively thinking through pre-deal tax planning has the potential to minimize any unplanned tax exposures as you advance your transaction with your target within cross-border interpretations:

• Confirm Treaty Benefits → Review relevant applicable U.S. and foreign treaties to take advantage of cross-border withholding tax rates and minimize the double taxation of income.

• Model Foreign Tax Credits (FTCs) → Model FTCs to determine amounts that limit or eliminate tax leakages that impact transaction valuations and prevent deals from closing due to tax principles.

• Review GILTI and BEAT Impacts → Evaluate a U.S. multinationals’ exposure regarding GILTI and BEAT when they enter or exit from a foreign jurisdiction.

During the Deal

Tax diligence during the transaction is critical to efficient deal structure and avoiding unpleasant last minute surprises:

• Confirm Withholding Tax Requirements → Based on a review of residency certificates from all parties for all cross-border payments to ensure the appropriate treaty withholding tax rates are all applied correctly.

• Structure Asset vs. Stock Purchase → Ultimately the preferred structure will vary based on tax efficiency, desired liability exposure and integration strategies post acquisition.

• Consider Transfer Pricing Compliance → Intercompany pricing policies will need to also be structured to abide by U.S. tax requirements and foreign localized tax requirements. Maintain a low audit risk profile by managing tax compliance policies between the related each entities.

Post-Deal Phase

When the deal closes, ensuring compliance and optimizing long term tax efficiencies as priorities:

• Plan for Repatriation Strategies → Identify the optimal tax efficient mechanism to repatriate profits back to parent entities, whilst minimizing additional tax exposure.

• Track Foreign Reporting Obligations → Ensure timely completion of filings such as for Form 5471 and other jurisdictional requirements, to avoid penalties.

• Maintain Treaty Compliance → Review the treaty based positions and supporting documents to ensure ongoing eligibility for reduced withholding rates and relief based on treaty.

Key Takeaway:

By establishing transaction phases ensures the deal team can address tax exposures much earlier in the transaction phase, structure transaction tax efficiently, and ensure compliance post-closing and during integration. Proactive planning is the difference between value being created and costs, in cross-border M&A.

Key Takeaways and Strategic Insights

Cross-border M&A can create an enormous number of opportunities for growth, international expansion, and shareholder value creation. But organizations must recognize that in an environment of changing U.S. and global tax rules, complicated treaty implications, and increased regulatory scrutiny, proactive tax planning is a must.

To create maximum value and mitigate risk, CFOs, dealmakers and tax leaders can:

• Plan for tax risks earlier so structures are developed with respect to timelines associated with the transaction.
• Optimize structures and transaction placement, to ensure operationalization of treaty benefits while increasing tax efficiency.
• Use phased tax diligence to monitor disclosures and develop an integration strategy.
• Leverage the use of technology and AI enabled insights to improve accuracy, speed, and reduce risk.

Organizations can create tax efficiencies, mitigate risk and drive sustainable value from cross border M&A activity through planning and structure.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com

The One Big Beautiful Bill Act of July 4, 2025, implements comprehensive tax changes that seek to encourage business expansion, spur private investment, and increase the competitiveness of the U.S. economy. Although the legislation affects various industries, its consequence on the Private Equity (PE) sector is especially noteworthy.

This presentation provides an overview of the One Big Beautiful Bill Act (OBBBA) and its legislative purpose, along with an overview of main tax provisions important to the private equity sector. It cites what has changed, i.e., interest deductibility and QSBS improvements, and what has been left alone, such as carried interest treatment. The deck discusses how these reforms affect the fund level and the level of portfolio companies and presents new structuring and planning opportunities on the horizon. Collectively, these findings provide a strategic perspective on how OBBBA is transforming private equity investment, operations, and exit planning.

Key Highlights of OBBB –

• Signed into law on July 4, 2025.
• Reinstates full expensing for qualified property via 100% bonus depreciation.
• Raises the expensing cap under IRC Section 179 to $2.5 million.
• Returns to EBITDA-based limitation for interest deductions under Section 163(j).
• Expands QSBS exclusion threshold and introduces tiered holding period benefits.
• Leaves carried interest and long-term capital gains rates unchanged.
• Omits proposed foreign investor withholding tax (Section 899).

These provisions significantly influence fund strategy, capital structure, and tax modeling.

Carried Interest – What didn’t Change

• OBBBA preserves the current tax treatment for carried interest.
• Gains remain eligible for long-term capital gains rates if held for three or more years.
• This is a key win for general partners (GPs):
  • Maintains incentive alignment
  • Supports fundraising confidence
  • Avoids disruption to fee structures
• Limited partners (LPs) also benefit:
  • Ensures predictable fund economics
  • Preserves net-of-fee return consistency

Interest Expense Deduction – IRC Section 163(j)

OBBBA resurrects the EBITDA-based restriction on interest expense deductions in place of the more constrictive EBIT-based rule. This amendment is especially helpful for leveraged buyouts, infrastructure transactions, and capital-intensive industries. It maximizes permissible deductions, better preserves free cash flow, and offers increased flexibility in structuring debt. PE companies can now manage optimal debt levels across portfolio companies without suffering compressed tax shields.

Metric	EBIT Limitation (Pre-OBBBA)	EBITDA Limitation (Post-OBBBA)
Deduction base	Earnings Before Interest & Tax	Earnings Before Interest, Tax, Depreciation, Amortization
Impact	Lower deductions	Higher deductions
Effect	Tighter leverage limits	More flexibility for LBOs

Bonus Depreciation & Section 179 Expensing

OBBBA permanently reinstates 100% bonus depreciation for eligible property that goes into service after January 19, 2025. This enables instant full expensing of capital expenditures, which is especially helpful to manufacturers, logistics companies, and energy producers. Also, the Section 179 expensing limitation has been increased to $2.5 million, promoting small and middle-market companies to invest more boldly in equipment, technology, and fixed assets, with quicker payback.

Tax Provision	Pre-OBBBA	Post-OBBBA
Bonus Depreciation	80%	100%
§179 Expensing Cap	$1.05 Million	$2.5 Million

QSBS Expansion – IRC Section 1202

• Exclusion cap increased to greater of $15M or 10× basis (up from $10M).
• Gross asset limit raised from $50M to $75M.
• Excess gains taxed at ~28% collectibles rate.
• Encourages private equity investment in startups & high-growth sectors.
• Supports earlier exits and C-corporation structuring flexibility.
• Tiered exclusions by holding period:

Foreign Investor Relief – Section 899 Removed

• Proposed Section 899, which would have imposed withholding taxes on foreign investors, was excluded from the final OBBBA legislation.
• This preserves the structural integrity of cross-border fund vehicles.
• Ensures the continued attractiveness of U.S. private equity to global limited partners (LPs).
• International fundraising efforts remain unaffected.
• Protects foreign investor participation without new compliance burdens.
• Reinforces the U.S. as a stable jurisdiction for inbound private capital.

Portfolio Company – Level Impact

The tax reforms enhance financial performance and operating efficiency for portfolio companies. Expensing of R&D and capital expenditures on an immediate basis, enhanced deductibility of interest, and depreciation recovery contribute to increased after-tax cash flows. This facilitates quicker reinvestment in growth, enhanced EBITDA margins, and better enterprise valuation. Tax savings also offer debt repayment or financing of new projects flexibility.

• Increased Cash Flow
• Accelerated Write-offs
• Immediate Deduction
• Enhanced Capital Allocation
• Increased Valuations

Fund – Level Planning Opportunities

OBBBA produces greater structuring flexibility and tax planning. GPs can now consider electing C-corporation status on selected entities to optimize QSBS incentives or align more with exit horizons. Greater interest deductibility allows for more leverage and refinanced capital structures. Exit projections and IRR modeling can be maximized by applying new depreciation schedules and staggered QSBS exclusions, producing greater returns to both GPs and LPs.

Unchanged Tax Provisions under OBBBA

These unchanged provisions provide a sense of regulatory certainty amid broader tax reforms. By keeping the existing rules for carried interest and long-term capital gains, OBBBA supports the core financial structure of private equity funds. Allowing PTET workarounds helps funds manage state taxes efficiently; while avoiding new taxes on BDCs and private credit protects alternative investment strategies. This stability gives GPs and LPs the confidence to move ahead with structuring, fundraising, and long-term planning.

Area	Status	Implication
Carried Interest	Unchanged	Retains GP economics
Long-Term CG Rate	Unchanged	Exit tax planning stable
SALT Cap Workaround	Preserved	PTET strategies valid
Foreign LP Tax	Removed	Global fundraising protected

Strategic Takeaways for Private Equity Sponsors

• OBBBA enhances the strategic tax levers of private equity firms.
• Increased accelerated depreciation and broadened QSBS benefits enhance value creation potential.
• Improved interest deductibility enables more effective leverage and capital structuring.
• Long-term capital gains stability and carried interest maintain predictable fund economics.
• Simplified rules and exemptions kept in place diminish uncertainty in fundraising and LP communications.
• Private equity firms are well-positioned to match exit strategies with tax-effective timelines.
• The Act establishes a stable, pro-growth tax climate for investors and funds.

Summary and Outlook

The One Big Beautiful Bill Act provides focused tax relief to private equity without upsetting bedrock aspects of the business. It increases tax planning, structuring of funds, and valuation levers without losing the established long-term incentives that inspire investor trust. In the short term, companies can take advantage of these changes to fine-tune models, sharpen strategies, and drive outcomes throughout fund lifecycles.

• Private equity Tax Relief: Focused and targeted; preserves core tax rules.
• Future Outlook: Use this window to optimize models and lifecycle planning.
• Strategic Advantage: Enables better fund structuring and valuation.

---

The information contained in this post is merely for informative purposes and does not constitute tax advice. For more information, feel free to reach us at info@swbadvisors.com

Copyright 2025 Small World Business Advisors LLC www.swbadvisors.com