TaxJourney®

The One Big Beautiful Bill Act (OBBBA) delivers transformative enhancements to Qualified Small Business Stock (QSBS) under Section 1202, redefining how founders, investors, and PE funds approach exit planning and valuation.
These reforms aren’t just incremental, they’re reshaping the economics of startup investing and M&A structuring.

1. Earlier Liquidity with Tiered Holding Periods
Under the OBBBA 2025 framework, Qualified Small Business Stock (QSBS) issued on or after July 4, 2025 will follow a tiered capital gain exclusion schedule:

• 50% exclusion after 3 years
• 75% exclusion after 4 years
• 100% exclusion after 5 years

This replaces the previous 5-year cliff model, allowing investors to unlock earlier liquidity while still accessing meaningful tax benefits. The change is expected to influence exit planning, especially for founders, angel investors, and private equity funds seeking more flexible timelines.

2. Larger Tax Benefits with Increased Caps

• The lifetime per-issuer cap will raise from $10M → $15M.
• The 10× basis limitation stays the same.
• The new $15M cap is inflation-indexed beginning 2027, which provides long-term flexibility for founders, angels, and fund LP/GP arrangements.

3. Broader Eligibility – More Companies Are Eligible

• Asset limit for the issuer increases from $50M → $75M (also inflation-indexed beginning 2027).
• This update makes more capital-intensive and larger startups, as well as PE-backed portfolio companies, eligible for QSBS.

Private Equity and Startups: Why This Matters

• Faster secondary sales and exits, Investors can realize partial exclusions without waiting five years.
• Because there are additional qualifying companies, there are additional deal opportunities cantered around QSBS benefits.
• More planning, Broader eligibility and greater caps provide for more sophisticated portfolio strategies.

Key Takeaway:

With OBBBA 2025, QSBS is now more powerful, more flexible, and more valuable than ever, enabling tax-efficient exits and unlocking broader investment opportunities for funds and founders alike.

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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 [email protected]

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

The One Big Beautiful Bill Act (P.L. 119-21) marks one of the most consequential tax shifts in recent years, especially for private equity stakeholders.

From deal structuring and investment strategy to cross-border planning and compliance, this legislation introduces reforms that demand a fresh look at how capital is deployed and returns are realized.

Whether you’re a fund manager, family office, or portfolio company, understanding these changes is no longer optional, it’s essential.

Here are the key provisions every private equity stakeholder should be tracking:

1. Business Interest Limitation IRC §163(j): The Act reinstates the EBITDA-based method for calculating Adjusted Taxable Income (ATI), improving interest deductibility on leveraged buyouts and debt-funded deals. Starting in 2026, select foreign income exclusions will apply, further impacting interest deductibility.

2. 100% Bonus Depreciation & R&D Expensing: Portfolio companies can now fully expense capital investments upfront, boosting liquidity and cash flow. Domestic R&D costs are deductible in the same year, supporting innovation-driven businesses.

3. QSBS Expansion: QSBS benefits are significantly enhanced with higher exclusion thresholds and a tiered structure, making early-stage investments more tax-efficient and elevating VC-style strategies within private equity.

4. Carried Interest Treatment Remains Unchanged: Carried interest retains its long-term capital gains classification, preserving after-tax returns for fund managers and GP teams.

5. Gift & Estate Tax Exemption Increases: Higher exemption thresholds allow HNW LPs and fund principals to transfer wealth more efficiently, offering greater flexibility in estate planning.

6. International Tax Updates: OBBBA aligns U.S. international tax rules with global standards, streamlining treaty benefit claims and improving clarity for cross-border private equity investments.

7. Disguised Sales & Partnership Rules: The Act broadens the scope of taxable disguised sales, requiring LPs to reassess partnership allocations and exit strategies to avoid unintended tax exposure.

8. Excess Business Loss (EBL) Limitations: EBL limitations are now permanent, standardizing how portfolio-level losses are offset and enabling more confident long-term tax planning.

These reforms are more than technical, they’re strategic. They influence how capital is deployed, how returns are realized, and how tax impacts the private equity lifecycle.

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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 [email protected]

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

The One Big Beautiful Bill Act (OBBBA) represents a turning point in American tax policy, moving theoretical reform into legislation. Its measures revive and improve key tax incentives, such as 100% bonus depreciation, permanent Section 179 expensing, reinstated EBITDA-based interest deductibility, and enhanced Qualified Small Business Stock (QSBS) exclusions, that business buyers and sellers are now forced to factor into deals. These developments rebalance purchase price allocations, priorities for due diligence, and valuation models, especially in asset-heavy or pass-through deals common in M&A. What were once tax tailwinds or modest adjustments are now core drivers of deal economics.

In a post-OBBBA environment, M&A planning needs sophisticated tax planning throughout the board, from term sheet negotiation to integration and exit modelling. Buyers must project how leveraged finance and accelerated expensing affect cash flow and return projections; sellers may need to change structures to exploit QSBS benefits or preserve pass-through deductions. Cross-border investors now face new challenges to navigate with the impact of updated GILTI rules and reevaluated FTC structures. Simply put, tax expertise incorporated into valuation, financing, and structuring is now a critical part of successful deal execution, not an afterthought, but a foundational element of M&A strategy.

Quick Takeaways

• 100% Bonus Depreciation → Immediate asset expensing
• Section 179 Expensing → Increases capital investment efficiency
• EBITDA-Based Interest Caps → Impacts financing models
• QSBS Benefits → Tax-free gains optimization

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Evolving Tax Landscape Under ‘One Big Beautiful Bill’ – A Snapshot of Structural Tax Changes

Key Tax Changes Relevant to M&A

• 100% Bonus Depreciation & Section 179 Expansion: OBBBA reinstates 100% bonus depreciation for qualifying properties acquired in after January 19, 2025 (with a transitional 40%/60% election available for the first tax year ending after that date), and doubles the Section 179 expensing cap to $2.5M (phase-out begins at $4M). M&A Implication: Buyers of asset-heavy businesses can now front-load tax deductions, enhancing post-deal cash flow—but these benefits can create tension during purchase price allocation, as sellers may seek to minimize depreciation recapture.
• State & Local Tax (SALT) Cap Relief and PTET Preservation: The SALT cap increase to $40,000 is temporary (2025–2029), with a phase-down for incomes above $500,000 and potential reversion to $10,000 afterward, and pass-through entity tax (PTET) workarounds remain intact. M&A Implication: Sellers structured as pass-throughs in high-tax states retain valuable tax efficiency, aiding negotiation and valuation in asset sale structures.
• Permanent QBI Deduction (Section 199A): The 20% Qualified Business Income deduction for pass-through entities is now permanent. M&A Implication: Reduces effective tax exposure for seller entities, smoothing structural discussions and potentially enhancing seller net proceeds.
• Immediate Expensing of R&D Costs: Domestic R&D costs are fully deductible in the year incurred (no longer amortized over five years), effective for tax years starting after 2024. M&A Implication: Targets in innovation-driven sectors become more attractive to buyers due to improved after-tax earnings projections.
• Interest Deductibility Based on EBITDA: The more generous EBITDA-based limit is restored for business interest deductions (as opposed to the narrower EBIT test). M&A Implication: Enables higher leverage capacity within deals-especially for PE-backed acquisitions by expanding interest deductibility.
• Cross-Border and FTC/NCTI Changes: While not M&A-specific, the revamp of GILTI to Net CFC Tested Income (NCTI), enhanced Foreign Tax Credit mechanics, and revised treatment for mid-year CFC dispositions. M&A Implication: Affects deal structuring considerations for cross-border transactions, particularly for global fund or multinational entity buyers.

How These Reforms Reshape Transactions

M&A Impact Area	Key Tax Change	Deal-Level Implication
Purchase Price Allocation	Bonus depreciation & R&D expensing	Buyers may request asset-heavy allocations; seller recapture risk must be managed
Valuation Modelling	R&D, EBIDTA deduction shifts	Buyers must revisit DCF models to incorporate tax-boosted cash flows
Financing Flexibility	EBITDA vs EBIT limits	PE buyers gain increased leverage capacity and improved interest smoothing
Target Pool Attractiveness	QBI, R&D, depreciation tools	Innovation-rich and capital-intensive targets become more attractive
Cross-Border Strategy	NCTI/FTC revisions	Global M&A stakeholders need to reassess entity structuring to optimize tax

Increased Compliance & Reporting Focus

While not as M&A-specific, some measures demand closer attention from advisors:

• Expanded Reporting for Partnerships & Entities: Required disclosures (such as for Qualified Opportunity Funds) and penalty structures are now larger.
• Operational Diligence: Buyers must assess whether targets can support the required tax accounting, reporting, and audit readiness under the new rules.

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Key Impacts of OBBBA on M&A Deals

A. Deal Structuring Adjustments

• Asset Deals Become Even More Attractive – With OBBBA restoring 100% bonus depreciation permanently and increasing the Section 179 expensing limit to $2.5 million, purchasers can hasten tax recovery and enhance cash flow following an acquisition. This tax benefit also shifts deal structures more towards asset acquisitions, as acquiring firms want to “step up” asset bases to maximize deductions.
• Negotiation Dynamics – Price Allocation Tensions – Acquirers prefer asset-biased allocations, whereas sellers prefer to minimize depreciation recapture exposure. This phenomenon increases in OBBBA’s tax regime, introducing intricacies into purchase price allocation (PPA) deal negotiation.

B. Valuation Dynamics

• By bringing back full bonus depreciation, the OBBBA increases the appeal of asset-intensive companies (such as manufacturing or high R&D), whose valuations could be raised. Enhanced depreciation treatment and leverage flexibility can lower purchaser financing costs and enhance returns.
• Impact on Buyers: Improved cash flow expectations after purchase.
• Impact on Sellers: Higher valuations and more buyer competition for targets with high capital bases.

C. Cross-Border Transaction Complexities

Internationally, OBBBA brings important changes that have a direct impact on cross-border M&A:

• GILTI is replaced by Net CFC Tested Income (NCTI), expanding taxable reach of CFC income.
• Improved Foreign Tax Credits (FTC): eliminates previously mandatory allocations of interest & R&E expense, facilitating increased credit availability.
• Pro-rata allocation of income for mid-year CFC sales, adding complexity to deal-year tax planning.
• These changes have an impact on structuring considerations, requiring close tax modelling in cross-border transactions.

D. QSBS Benefits & Exit Strategies

OBBBA strengthens Qualified Small Business Stock (QSBS) provisions, directly influencing deal planning and exit strategies in M&A. These revised benefits apply to stock issued after July 4, 2025; earlier issuances retain the original 5-year/100% rule without partial exclusions. Key Impacts on M&A:

• Higher Tax-Free Gains – The exclusion cap rises from $10M to $15M, making equity exits more lucrative.
• Broader Eligibility – The gross asset threshold increases from $50M to $75M, allowing more companies to qualify for QSBS benefits.
• Faster Exit Opportunities – Partial gain exclusions are now available after 3–4 years, enabling earlier monetization of investments.
• This expansion boosts valuations for high-growth companies, makes startups and mid-sized businesses more attractive acquisition targets, and provides buyers and sellers with greater deal structuring flexibility to optimize returns.

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Due Diligence Imperatives

Enhanced Focus on Tax Due Diligence Under OBBBA:

Under the OBBBA framework, comprehensive tax due diligence has become a critical requirement for securing successful M&A transactions. The permanence of key provisions, such as bonus depreciation, Section 179 expensing, and EBITDA-based interest limitations, introduces new tax planning opportunities but also creates potential areas of risk if not thoroughly evaluated.

Structural tax changes, including the transition from GILTI to NCTI, enhanced availability of foreign tax credits, and accelerated depreciation rules, require rigorous assessment during due diligence. These factors directly influence pricing strategies, deal structuring, indemnity negotiations, and overall transaction viability.

Additionally, reforms to depreciation and financing regulations may significantly affect enterprise valuations. Valuation models now need to be recalibrated to reflect updated cash flow expectations and the integration of new tax mechanisms, underscoring the need for heightened scrutiny when aligning a target’s financial and tax profiles under the OBBBA regime.

Identifying Hidden Liabilities in Advance to Prevent Post-Deal Disputes:

Reinstated tax provisions by OBBBA may lead to book-tick, tax-whack mismatches, concealed liabilities, or distortions in reported earnings.

Since bonus depreciation and accelerated write-offs of R&E are now available, buy-side teams need to ensure that targets don’t unintentionally misreport deferred tax liabilities or misallocate expenses, which can cause post-close adjustments.

Effective due diligence requires moving beyond surface-level financials to evaluate underlying tax positions, especially when assessing asset-heavy or highly leveraged targets.

AFSI Considerations in Partnership-Based Deal Structuring:

While the term Adjusted Financial Statement Income (AFSI) is not explicitly discussed in many OBBBA-related resources, its relevance in partnership-driven M&A transactions is significant. Under the OBBBA framework, the conversion of GILTI to NCTI and modifications to foreign tax credit rules directly affect multi-tiered structures and foreign-controlled entities.

For purchasers, accurately evaluating AFSI calculations before and after OBBBA implementation is critical to understanding the true tax exposure of the target entity. This becomes especially important in private equity and partnership-based deals, where non-corporate entities may now report materially different taxable income. Such discrepancies can directly impact waterfall models, GP/LP distributions, and projected cash flows, making thorough analysis and modelling a key component of successful deal structuring.

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Risk Mitigation & Strategic Planning

OBBBA has reshaped the tax landscape, increasing the need for deeper due diligence and forward-looking planning. From modeling deal structures to mitigating hidden tax risks, the following strategic priorities outline how buyers and sellers can better navigate complex M&A environments.

Strategic Area	Key Focus	Impact on M&A	Recommended Actions
Deal Model Flexibility	Integrating OBBBA-related variables like depreciation reforms, EBITDA caps, and NCTI adjustments	Shifts taxable income projections and impacts overall deal valuations	Build dynamic deal models with multiple scenarios to assess exposure levels
Tax Optimization Opportunities	Utilizing elections, credits, and structuring options under OBBBA	Potential to minimize tax liabilities and maximize post-deal returns	Evaluate Section 179, bonus depreciation, and FTC provisions during planning stages
Cross-Border Considerations	Adapting to revised foreign tax credits and tax requirements	Impacts financing structures and global effective tax rates	Coordinate early with cross-jurisdictional tax advisors to mitigate compliance risks
Regulatory Monitoring	Ongoing modelling of OBBBA variables and deal-year effects (e.g., interest, depreciation, CFC allocation)	Minimizes risk of unexpected exposures or post-deal disputes	Establish continuous monitoring and update deal documents as guidance evolves
Risk Containment Measures	Identifying hidden tax risks during due diligence	Ensures accurate pricing and reduces potential indemnity claims	Deep tax diligence on bonus depreciation/§179, interest-limit impacts, and cross-border NCTI/FTC modelling.

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Strategic Outlook On M&A In A Changing Tax Landscape

As the One Big Beautiful Bill Act (OBBBA) continues to take shape in practice, its influence on M&A dynamics is set to extend well beyond current deal structures. The permanence of provisions such as accelerated expensing, EBITDA-based interest deduction rules, and enhanced pass-through incentives is already reshaping valuation benchmarks and financing strategies. Dealmakers who anticipate these shifts and proactively adapt their models will be better positioned to achieve competitive valuations, optimize capital structures, and execute transactions designed to withstand evolving tax frameworks.

Moreover, the legislative and regulatory landscape remains fluid, with forthcoming IRS guidance and interpretive updates expected to refine OBBBA’s practical application. This makes continuous tax monitoring and strategic planning integral to successful deal execution. Whether managing layered financing arrangements, structuring cross-border transactions, or modelling complex waterfalls, early integration of tax considerations has become a decisive advantage. Tax planning is no longer a technical formality; it is a strategic differentiator that drives value creation and ensures resilience in an ever-changing M&A environment.

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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 [email protected]

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

The One Big Beautiful Bill Act (OBBBA) introduces targeted modifications that intersect directly with the Corporate Alternative Minimum Tax (CAMT) regime. While several provisions create new planning opportunities for private equity (PE) funds and portfolio companies, the legislation also preserves key tax treatments that support market stability.

For fund managers, these changes require balancing immediate opportunities with longer-term strategic considerations in modeling, structuring, and investor communications. Importantly, many of OBBBA’s favorable “regular” tax provisions may unintentionally increase CAMT exposure. This is because they reduce taxable income without lowering adjusted financial statement income (AFSI). The result: potential CAMT liability even in years when regular tax benefits are available, along with challenges in utilizing CAMT credits under general business credit ordering rules.

CAMT Update Expands Options for Partnerships While Urging Prudence

The Treasury and IRS recently released Notice 2025-28 (the “Notice”), which sets out measures intended to simplify how the CAMT rules apply in the context of partnerships. Although positioned as a compliance-friendly step for corporations with partnership interests, the real-world application is more complex than the initial framing might imply, and the flexibility offered comes with important practical considerations.

In many cases, reliance on the Notice will also require reliance on portions of the CAMT proposed regulations, bringing with them their inherent complexities. Moreover, several of the elections introduced under the Notice are not straightforward to apply and may carry adverse consequences in subsequent years.

To navigate these provisions effectively, taxpayers will need to model the potential effects of making the available elections or otherwise applying the Notice, taking into account both current and future AFSI impacts. Given the binding nature of these elections, a multi-year forecasting approach is essential before making any decisions.

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Approaches to Determining AFSI from Partnership Investments

Following the release of Notice 2025-28, applicable corporations now have multiple possible methods for determining their adjusted financial statement income (AFSI) related to partnership investments, even in situations that do not involve direct contributions to or distributions from the partnership.

These methods can generally be grouped into top-down and bottom-up approaches, each with variations depending on the financial accounting treatment, applicable rules, and elections available.

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Key Considerations for Applying the Notice’s New and Elective Rules

When determining an applicable corporation’s distributive share of AFSI under the partnership rules in Notice 2025-28, several practical points require attention:

• Neither the Top-Down Election nor the Taxable-Income Election can be applied straight from reported financial statement income (FSI) or taxable income. Both require specific modifications to ensure the AFSI amount linked to the partnership is accurately calculated.

• Corporations are allowed to make different elections for different partnerships, even mixing Top-Down and Taxable-Income Elections across their portfolio. While this tailored approach can improve outcomes, it is subject to certain constraints and benefits most from robust modeling.

• Opting for either election means early adoption of the “-5” rules and a binding choice that generally stays in place until updated regulations are released. Given the long-term nature of these elections, multi-year projections and a clear view of the broader -5 rule impacts are essential before making a decision.

• Confirming qualification for this election can be complex, often requiring swift information exchange within a section 52 group or a foreign-parented multinational group. This data may not always be readily available within the short decision window.

• Despite its name, the Reasonable Method provides only limited flexibility. It applies when partnerships, under the -5 rules, calculate and report Modified FSI, and it places the responsibility for allocating those amounts on the partnership. While there is some discretion in setting allocation percentages, the practical range of options is narrower than the name suggests.

1. Top-Down Election

• Includes in AFSI 80% of a top-down amount for a partnership investment, after adjustments.
• Eligibility: Applicable corporation partners.
• Not available to upper-tier partnerships (even if they have applicable corporations as partners).
• Start with the CAMT entity’s FSI from the partnership.
• Adjust for certain items, then reduce by 20%.
• Apply additional adjustments to determine final AFSI.
• Election is made in the partner’s return for the election year, on an investment-by-investment basis.
• Likely requires adoption of the proposed -5 rules.
• More complex than some statutory top-down methods.
• Likely requires use of this method (or Taxable-Income Election / -5 rules) for all partnership investments.
• Could have negative AFSI impact if the partnership interest is sold.
• Loss limitation rules apply.
• Requires tracking the partner’s CAMT basis in the partnership investment.

2. Reasonable Method

• Lets the partnership use any reasonable method to determine each partner’s distributive share percentage of Modified FSI.
• Eligibility: Partnerships that have early adopted the -5 rules and are computing Modified FSI.
• Partnership calculates each partner’s share of Modified FSI.
• Uses a Reasonable Method to set allocation percentages.
• Partnership includes a statement in its return describing the method used.
• Requires partnership adoption of the proposed -5 rules.
• Binding on the partnership until the tax year before revised proposed regulations.
• Allows use of a tax provisions-based ratio instead of a book-based ratio.
• Moves the burden of distributive share calculation from partner to partnership.

3. Taxable-Income Election

• Uses the partnership’s taxable income (with adjustments) to determine AFSI.
• Eligibility: Applicable corporation partners whose CAMT test group:
  • Owns ≤ 20% profits/capital interest, and
  • Has < $200M FMV in the partnership investment.
• Not available to upper-tier partnerships (even with applicable corporations as partners).
• Start with the CAMT entity’s taxable income from the partnership.
• Adjust for specific items to arrive at AFSI.
• Election is made in the partner’s return for the election year, on an investment-by-investment basis.
• Likely requires adoption of proposed -5 rules.
• Binding on the partner until the tax year before revised proposed regulations, or earlier if eligibility ends.
• Simpler than -5 rules.
• Tax-based starting point (rather than book-based) can mean lower AFSI.
• Eligibility testing is complex and must be done each year.
• Likely requires use of this method (or Top-Down / -5 rules) for other partnership investments.
• Negative AFSI impact possible if the partnership interest is sold.
• Loss limitation rules apply.
• Requires tracking the partner’s CAMT basis in the partnership investment.

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Approaches to Partnership Transactions under CAMT

In certain cases, a tax-free contribution to or distribution from a partnership can unexpectedly give rise to adjusted financial statement income (AFSI) for purposes of the Corporate Alternative Minimum Tax (CAMT). Recognizing this, the Treasury and IRS have exercised their regulatory authority to introduce mechanisms aimed at reducing or deferring that impact.

Following the release of Notice 2025-28, taxpayers now have a menu of six distinct approaches to postpone, for CAMT purposes, the financial statement income associated with such transactions. The choice of method often depends on whether the election is made at the partner level, the partnership level, or under specific eligibility conditions.

• An updated take on the proposed rules in Prop. Reg. Sec. 1.56A-20, offering an alternative computation for partnership contributions and distributions when chosen by an applicable corporate partner.
• A partnership-level election, requiring the agreement of all impacted partners, that applies Subchapter K principles for CAMT purposes to mirror conventional partnership tax treatment.
• Available to eligible partners, this option uses the partnership’s taxable income, rather than its financial statement income, as the starting point for calculating the partner’s share of AFSI.
• -20 Rules Without -5 Rules – Implements the original -20 rules in combination with certain designated regulations, but deliberately omits the -5 rules from application.
• -20 Rules With -5 Rules – Integrates the -20 rules, the -5 rules, and the designated regulations into a coordinated approach for determining AFSI.
• Reasonable Statutory Interpretation – Applies a taxpayer’s justified interpretation of the statute, which could support either full recognition of partner-level FSI from a contribution or complete exclusion of such income when contributed property is involved.

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Deferring FSI from Partnership Contributions and Distributions : Key Methods

1. Modified -20 Method

• An election for any CAMT entity partner to apply the proposed -20 rules with targeted modifications, in order to determine AFSI from partnership contributions and distributions.
• Any CAMT entity partner is eligible.
• Include the election in the partner’s tax return for the election year.
• Likely requires adoption of the proposed -20 rules by the electing partner.
• Unclear if adoption of the proposed -5 rules is also necessary.
• Once elected, binding until the tax year before revised proposed regulations take effect.
• Generally simpler than the original proposed -20 rules.
• May offer more favorable treatment in certain areas (e.g., partnership debt, recovery rules, and acceleration events).
• In some cases, could be less favorable than the original -20 rules.
• Uncertainty on how the election affects partnership-level reporting.
• Partnerships may need to maintain multiple CAMT books to track deferred sales property and related gain/loss events.

2. Full Subchapter K Method

• An election by the partnership (with consent of all relevant partners) to apply Subchapter K principles when determining AFSI for contributions and distributions.
• Only partnerships, not individual partners are eligible.
• Election is made in a partnership’s tax return for the election year.
• Must be applied to all contributions and distributions for the partnership.
• Once made, binding until the tax year before revised proposed regulations take effect.
• In certain situations, more favorable than both the original -20 rules and the Modified -20 Method.
• Creates a complex, parallel compliance system that may raise additional technical questions (e.g., handling partner-level FSI from contributions).
• Requires significant time and administrative investment.
• In some cases, could be less favorable than the other two methods.

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Further Provisions under Notice 2025-28

In addition to its primary provisions, Notice 2025-28 introduces several clarifications relevant to taxpayers adopting the proposed -5 and/or -20 rules. One significant change allows taxpayers to exclude from AFSI any financial statement income resulting from consolidation, remeasurement, deconsolidation, dilution, or ownership changes involving another partner, so long as the event does not constitute a realization event.

The Notice also extends the reporting timelines for partnerships, providing more time to supply CAMT-related information to partners in accordance with the proposed regulations.

With respect to reliance rules under the proposed regulations, taxpayers are now permitted to adopt either the -5 rules or the -20 rules independently, rather than being required to adopt both—a “decoupling” approach. However, it appears that early adoption of the specified regulations remains a prerequisite.

Finally, for those relying directly on Notice 2025-28, there is an added degree of flexibility: taxpayers may adopt either the -5 rules or the -20 rules, as modified by the Notice, without also adopting the specified regulations or adhering to the test group consistency requirement.

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Positioning for What Comes Next

Given the interaction between the OBBBA provisions and the elections under Notice 2025-28, taxpayers should conduct detailed, multi-year modeling to assess potential CAMT impacts. While certain OBBBA changes are favorable for regular tax purposes, they can also increase CAMT liabilities. Because these elections are binding, a thorough evaluation of their effect on AFSI, timing, and administrative requirements is essential. Strategic selection, based on a company’s specific facts, can offer meaningful advantages.

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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 [email protected]

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

Tax due diligence is a critical process in mergers and acquisitions, aimed at providing a comprehensive evaluation of a company’s tax position. This includes identifying potential exposures, uncovering unpaid tax obligations, and exploring opportunities for reducing tax liabilities, ultimately ensuring clarity and minimizing risks during the transaction.

Traditionally viewed as a buyer-centric activity, tax due diligence also offers significant advantages to sellers. By engaging a specialized sell-side team, sellers can thoroughly review their operations, pinpoint tax related risks, and implement effective remediation plans. This proactive approach allows sellers to address and resolve potential issues ahead of buyer scrutiny, facilitating smoother negotiations and enhancing overall deal value.

Significance of Tax due diligence for Buyers:

• Undisclosed Tax Liabilities: Targets may have hidden obligations such as unpaid corporate taxes, unresolved indirect tax issues, or pending payroll tax liabilities.
• Transfer Pricing Compliance: In cross-border transactions, under-documented or misaligned intercompany pricing can attract regulatory scrutiny and penalties.
• Verification of Tax Incentives: Significant tax incentives such as R&D credits or investment subsidies claimed by the target may later face challenges, leading to clawbacks or penalties if not properly substantiated
• Utilization of Tax Attributes: Valuable tax attributes, like net operating losses (NOLs), can become restricted or less valuable once ownership changes.

Significance of Tax due diligence for Sellers:

• Legacy Tax Disputes: Unresolved or ongoing tax audits and disputes can dissuade potential buyers or force a downward adjustment in deal pricing.
• Exit Taxation Challenges: The sale of a business may trigger significant capital gains or withholding taxes, directly impacting net sale proceeds.
• Indemnity and Warranty Arrangements: Buyers tend to demand robust tax indemnities to protect against post-closing surprises, potentially exposing sellers to extended risk.
• Cross-Jurisdictional Tax Compliance: International transactions may entail diverse tax regimes, which can expose sellers to risks such as unanticipated withholding taxes on repatriated funds.

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Tax Structuring

Tax structuring in mergers and acquisitions (M&A) is a sophisticated process aimed at optimizing the deal architecture to minimize tax liabilities for both buyers and sellers. It involves a comprehensive evaluation of the transaction form, whether it be a stock purchase, asset acquisition, or merger and a thorough assessment of the target’s tax attributes alongside the tax profiles of the parties involved.

• Deciding between a stock purchase, asset purchase, or merger carries distinct tax consequences. For instance, asset acquisitions may allow for a step-up in basis, enabling accelerated depreciation and immediate tax deductions, whereas stock purchases generally preserve existing tax attributes, such as net operating losses, but may also transmit legacy tax issues.
• Evaluating the target’s historical tax attributes, such as net operating losses, tax credits, and depreciation schedules is critical. These factors can significantly affect the overall tax efficiency of the transaction, influencing both the structuring and the valuation of the deal.
• The tax classification of the entities involved plays a crucial role. For example, aligning the deal structure with the buyer’s and seller’s tax status can help mitigate adverse tax consequences, ensuring that the planned benefits, whether through deductions or credits, are fully realized.
• Utilizing pass-through entities, such as LLCs and S corporations, can offer additional layers of tax efficiency. These structures often facilitate the flow-through of income and deductions, thereby avoiding double taxation at the corporate level.

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Post-Merger Integration

Post-Merger Integration (“PMI”) is essential for unifying the disparate strategies and objectives of merging entities under a cohesive long-term vision. By ensuring strategic alignment, PMI harmonizes varying goals to facilitate the realization of synergies, such as increased market share, cost efficiencies, and improved access to innovative technologies that drive value creation. In addition, the process emphasizes operational efficiency by consolidating processes, eliminating redundancies, and establishing a unified operating model.

Recognizing the critical importance of human capital, a robust PMI strategy also prioritizes cultural integration, bridging differences to foster a collaborative and cohesive workplace. Ultimately, effective PMI sustains business momentum and enhances financial performance, thereby delivering significant value to shareholders and ensuring the long-term success of the combined organization.

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Exit Planning

Firms must determine the optimal transaction structure (e.g., whether an asset or share sale) to minimize capital gains and manage deferred tax liabilities. Timing is critical due to shifting tax regulations, and cross-border deals add layers of complexity with varying local tax laws and potential double taxation. Additionally, safeguarding tax attributes like net operating losses or credits is vital to preserving post-exit value. We help by crafting exit strategies that minimize tax burdens while maximizing deal value by evaluating whether an asset or share sale best suits the client’s needs, advise on optimal timing amidst evolving tax laws, and manage cross-border tax complexities. In order to preserve valuable tax attributes (e.g., net operating losses and credits) ensuring that the exit is as tax-efficient as possible.

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Preserving Key Attributes

Preserving key tax attributes (most importantly net operating losses (“NOLs”)) in mergers and acquisitions presents a multifaceted challenge, compounded by evolving tax regulations and cross-border complexities. Below is an enhanced overview of the primary challenges and strategic considerations:

• Change-of-Ownership Limitations: Under Section 382, significant ownership changes cap the annual offset of pre-acquisition NOLs, diminishing their post-transaction value. Careful planning is key to managing this limitation and preserving effective utilization.

• Structural Trade-Offs: Transaction structure is key. Asset sales may trigger a basis reset that risks NOL continuity, while stock sales typically preserve tax benefits but could bring legacy liabilities. Tax-deferred reorganizations often provide a balanced, tax-neutral alternative.

• Emerging Tax Burdens: The dynamic tax landscape marked by global minimum taxes, revised depreciation rules, and intensified compliance requirements demands precise forecasting and innovative structuring strategies to protect and optimize tax benefits established at closing.

• Double Taxation Risks: In cross-border transactions, varying local tax laws can lead to double taxation when NOLs recognized in one jurisdiction are not fully acknowledged in another. Effective tax planning, leveraging tax treaties and aligning domestic treatments is essential to mitigate these risks.

At SWBA, we begin with meticulous due diligence, assessing key tax attributes such as net operating losses, credits, and liabilities to ensure a comprehensive understanding of both risks and opportunities. We assist with selecting the optimal transaction structure, whether that be an asset sale, stock purchase, or tax-deferred reorganization to maximize tax benefits while addressing change-of-ownership limitations and managing legacy liabilities effectively. Through specialized cross-border tax planning, we navigate the complexities of multi jurisdictional regulations, mitigating double taxation risks through strategic use of tax treaties and aligned domestic treatments. Our proactive approach to evolving tax regulations, including global minimum taxes and updated depreciation rules, safeguards your post-transaction tax profile and ensures long-term compliance and financial efficiency.

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Next Wave of Cross-Border Mergers and Acquisitions

Shaping Tomorrow’s Global Deals

Cross-border mergers and acquisitions (M&A) remain a vital element of global business growth, empowering companies to broaden their market presence, strengthen competencies, and achieve cross-border synergies. With the evolving landscape influenced by globalization, changing tax regulations, and dynamic trade policies, businesses must navigate new challenges and seize emerging opportunities to stay ahead. Below is a detailed exploration of the key factors shaping the future of cross-border M&A.

Emerging Markets & Digital M&A

Businesses are increasingly targeting emerging economies, capitalizing on high-growth regions fueled by a rising middle class, accelerated urbanization, and technological advancements. Simultaneously, the rapid proliferation of digital technologies is transforming industries like fintech, e-commerce, and renewable energy, driving global M&A activity and fostering strategic, innovative collaborations.

Global Taxation Challenges

Governments worldwide are enforcing increasingly stringent tax policies through initiatives like Base Erosion and Profit Shifting (“BEPS”) and General Anti-Avoidance Rules (“GAAR”), necessitating precise and strategic tax planning to ensure compliance while protecting value. Cross-border transactions pose challenges in transfer pricing, requiring well-structured strategies to align with international regulations and prevent disputes. The effective utilization of bilateral tax treaties is critical for minimizing withholding taxes and enhancing cash flow efficiency in global operations.

Evolving Trade Patterns and Geopolitical Changes

The rise of protectionism has introduced significant obstacles for cross-border mergers and acquisitions, as heightened scrutiny over foreign investments in strategic industries, often tied to national security concerns, limits deal opportunities. Geopolitical tensions, including trade sanctions, political instability, and economic nationalism, further complicate the landscape requiring businesses to develop agile and adaptive strategies. Additionally, currency volatility presents risks to transaction valuations and financial outcomes, making the implementation of effective hedging strategies an essential aspect of comprehensive transaction planning.

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Industry Focused M&A Tax Solutions

Financial Services

Banking, insurance, and fintech: conduct meticulous due diligence to uncover hidden liabilities, streamline tax compliance, and navigate integration challenges such as aligning regulatory frameworks and mitigating double taxation.

Healthcare

Scrutinize R&D and clinical trial costs to maximize credits while optimizing transfer pricing across entities. This targeted approach uncovers hidden liabilities and streamlines the tax structure for a more efficient post-deal integration.

Manufacturing

Verification of fixed asset records and depreciation schedules to ensure accurate write-offs and valuations by assessing intercompany transactions and supply chain arrangements to uncover hidden liabilities while leveraging incentives like accelerated depreciation and energy efficiency credits, optimizing the deal’s tax structure for a smoother integration.

Technology

In the technology sector, encompassing software, SaaS, and artificial intelligence, we streamline deal value by optimizing R&D credits and structuring IP transactions for tax efficiency all while adapting to rapidly evolving business models. In the technology sector, encompassing software, SaaS, and artificial intelligence, we streamline deal value by optimizing R&D credits and structuring IP transactions for tax efficiency all while adapting to rapidly evolving business models.

Real Estate

From property taxes and depreciation concerns to complex asset structuring. We tackle these issues by conducting precise due diligence to pinpoint exposures like depreciation recapture, advising on optimal transaction structures to maximize tax benefits.

Private Equity & Investment Management

We conduct deep due diligence to uncover hidden liabilities and advise on structuring deals for optimum tax outcomes. Structuring complex tax transactions, capital gains optimization, and cross-border compliance to ensure transactions are tax-efficient while safeguarding investor returns.

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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 [email protected]

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

Private equity funds allocate the proceeds from investment sales according to a defined hierarchy known as the “distribution waterfall.” Typically, the first tier of this waterfall involves returning “invested capital” to the investors, which generally includes their unreturned capital contributions attributable to realized investments and associated fund expenses such as management fees.

The second tier provides investors with a preferred return or hurdle rate on that capital. If the hurdle return applies, a third tier often follows, commonly referred to as the “catch-up”, which allows the general partner to receive the majority of subsequent distributions until it has received its full carried interest share of the fund’s net profits. Thereafter, any remaining proceeds are split between the investors and the general partner based on the agreed carried interest allocation.

Return of Capital

In contrast to hedge fund investors, who typically retain redemption rights, private equity investors receive liquidity incrementally as the fund exits its investments and distributes the proceeds. Accordingly, private equity funds distribute (rather than reinvest) the proceeds from each sale to return capital to investors over time. As noted earlier, the first tier in most distribution waterfalls is the return of invested capital. The specific definition of capital to be returned before the general partner becomes eligible for carried interest varies across fund agreements. Broadly, funds tend to follow one of three approaches to capital return: (i) deal-by-deal, (ii) realized net gain, or (iii) full aggregation.

Under a deal-by-deal approach, capital returned to investors typically includes only the amount invested in the specific asset sold, plus any related management fees. If the fund provides for a preferred or hurdle return, this amount may also include the associated return allocable to that investment. Since this method disregards unreturned capital tied to the fund’s remaining portfolio, it may allow the general partner to begin receiving carry distributions before the investors have fully recovered their total invested capital.

Example: Suppose a fund with a “deal-by-deal” distribution waterfall invests in A, B and C at a cost of $10 million each. At the end of the second and third years, the fund sells A for $8 million and B for $15 million (respectively). Assuming a 20% carried interest, the fund would distribute the entire $8 million from the sale of A to the investors as a partial return of their capital invested in A. At the end of the third year, the fund would distribute the first $10 million from the sale of B to the investors to return all of their invested capital in B and the remaining $5 million to the investors and the general partner on an 80/20 basis. Over the first three years, therefore, the general partner would receive $1 million of total distributions, which exceeds 20% of the net $3 million gain from the sale of A and B:

As illustrated in this example, a carried interest that participates only in investment gains is like a call option: the general partner shares in the profits on the gain investments (investment B) without sharing in the losses on the loss investments (investment A). This is why very few funds allow the general partner to participate in investment gains on a deal-by-deal basis. Fewer still follow this paradigm without imposing a “clawback” on the excess distributions at liquidation. If the fund in this example had imposed a clawback, the general partner would have been obligated to restore the $400,000 excess distribution ($1 million – (20% × $3 million)) upon liquidation unless the future sales proceeds from the sale of C were sufficient to reimburse the earlier loss on A.

In funds that net realized losses against realized gains, the first tier of the distribution waterfall also reimburses the investors for any unreturned capital on the previously sold investments of the fund. The general partner in a fund that follows this paradigm will not receive a carry distribution until the gain on the current investment exceeds the aggregate net losses on the previously sold investments. If the waterfall includes a preferred return, the general partner will not receive a carry distribution until the gain on the current investment also exceeds the sum of the preferred return on such investment and the accrued but unpaid preferred return on the previously sold investments.

Example: Same facts as in previous example except that the fund aggregates gains and losses. Rather than distributing a full 20% share of the $5 million of gain on the sale of B, therefore, the fund would distribute the first $2 million to the investors to reimburse the loss on A and the remaining $3 million (rather than $5 million) to the investors and the general partner on an 80/20 basis.

Other funds aggregate all invested capital. In these funds, the investors are entitled to distributions equal to 100% of their invested capital in the first tier of the waterfall, including capital allocable to the unsold investments in the fund. Because the capital allocable to the unsold investments may be substantial, the general partner in these funds is unlikely to receive any carry distributions until late in the life of the fund.

Example: Same facts as the previous example except that the fund distributes proceeds on a fully-aggregated basis. Because the investors still had $22 million of unreturned capital in the fund after the sale of A, they would receive the entire $15 million of proceeds from the sale of B as an additional return of capital distribution.

Preferred vs Hurdle Returns

In a typical private equity fund, the first tier of the waterfall includes a preferred or hurdle return on invested capital. From the general partner’s perspective, a preferred return functions similarly to a return of capital, it represents an amount that must be paid to investors before the GP becomes entitled to any carried interest.

A hurdle return, however, serves a distinct purpose: it subordinates the GP’s carry until investors have received a minimum threshold return. In funds with a hurdle, the total carried interest ultimately payable to the general partner mirrors what it would have been in the absence of a hurdle, assuming the fund achieves the requisite minimum return on capital. To accomplish this, most fund agreements provide for a “catch-up” distribution immediately following satisfaction of the hurdle, allowing the GP to receive the majority of subsequent profits until it has received its full share of the fund’s net gains. When the fund performs well, this catch-up mechanism effectively neutralizes the economic impact of the hurdle on the GP’s overall share of profits.

The Carried Interest

The general partner is entitled to a fixed percentage of the fund’s net gains, a figure that cannot be definitively calculated until the fund has exited all portfolio investments and completed its liquidation. Consequently, regardless of the distribution model applied, the general partner’s right to retain carried interest from earlier distributions remains conditional i.e., it does not fully vest until investors have received 100% of their invested capital plus their share of residual gains (e.g., 80% in a fund with a 20% carry).

Nonetheless, many funds permit the general partner to receive carried interest distributions prior to full investor recovery. This structure rests on the investors’ assumption that the fund’s remaining assets will ultimately generate sufficient proceeds to repay any outstanding capital, including unpaid preferred or hurdle returns. If this assumption proves incorrect, particularly if weaker-performing investments are sold later, the general partner may end up receiving more carry than warranted. The risk of such over-distribution is highest in funds that allow early carry payments without escrowing a portion of those distributions or recognizing unrealized losses on unsold assets.

To address this imbalance and ensure a full aggregation of gains and losses, most fund agreements include a “clawback” provision, requiring the general partner to return excess carried interest if final fund outcomes fall short of the investor priority returns.

Tax Distributions

Regardless of when carried interest is actually distributed, the general partner is taxed annually on its allocable share of the fund’s net income. In successful funds that follow a full-aggregation model, where all invested capital is returned before any carry is distributed, this means the general partner and its members may incur tax liabilities well before receiving any cash distributions. Similar liquidity challenges can arise in funds using a deal-by-deal or realized net gain distribution model, particularly if the general partner is permitted to reinvest sale proceeds rather than distribute them.

To address these timing mismatches between taxable income and cash distributions, nearly all private equity fund agreements include a tax distribution provision. This provision allows the general partner (and in some cases, other partners) to receive cash distributions solely to cover their tax obligations, even if such payments would otherwise violate the standard priority of the distribution waterfall. These tax distributions override the waterfall only to the extent necessary to enable the payment of taxes on current and prior-year allocable gains.

The purpose of the tax distribution mechanism is consistent with other partnership agreements i.e., to mitigate cash flow issues caused by differences in timing between profit allocations and actual distributions. A well-drafted fund agreement will ensure that any tax distribution is offset by prior amounts distributed to that partner, whether for tax or non-tax purposes. This ensures that no partner receives a tax distribution in any year unless their cumulative tax liability exceeds their cumulative prior distributions. In practice, this typically results in tax distributions being made only to the general partner.

In larger funds, tax-exempt and foreign investors who are generally not subject to U.S. tax on most categories of investment income often constitute the majority of the investor base. Despite this, it is rare for funds to exclude these investors from the tax distribution calculation. Typical tax distribution provisions assume the following:

• All investors are subject to U.S. federal income tax at the highest applicable marginal rate;
• All investors are subject to the highest possible state and local tax rates (e.g., those applicable in New York City or California);
• Investors do not have losses or deductions from other sources to offset their tax liability.

Additionally, a robust provision will compute each partner’s assumed tax liability on a cumulative basis. Under this approach, a partner is entitled to a tax distribution equal to the product of the applicable tax rate and the excess of cumulative taxable income allocated over cumulative prior distributions. Thus, a partner who has not received any prior distributions will only qualify for a tax distribution if their cumulative share of income exceeds their cumulative share of losses across all prior tax years.

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This article is a part of Private Equity series by Small World Business Advisors LLC and is intended to give a generic overview of the operational mechanisms of a typical private equity fund. Nothing herein constitutes tax or legal advice. For more information, feel free to reach us at [email protected]

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

Enacted on July 4, 2025, the One Big Beautiful Bill Act (“OBBBA”) constitutes a sweeping reform of federal tax and fiscal policy. Passed via budget reconciliation, the legislation integrates permanent extensions of prior tax provisions with newly enacted deductions, expanded reporting obligations, and targeted compliance mechanisms. The Act encompasses a broad spectrum of tax domains—including individual and corporate taxation, financial statement implications under U.S. GAAP, and administrative enforcement protocols.

While certain provisions are effective immediately, others are subject to phased implementation beginning in 2026. This document provides a structured summary of the Act’s principal tax-related measures, with particular focus on interpretive guidance issued by Treasury and IRS, effective date considerations, and areas where federal-state conformity may diverge— especially in fixed-date conformity jurisdictions.

R&D Tax Credit Coordination and Transition Rules

The Act introduces a coordinated approach between Section 174A, Section 41, and Section 280C to streamline how domestic research and experimental expenditures are treated for tax purposes.

Beginning with tax years after December 31, 2024, taxpayers must either reduce their deduction or capitalization of domestic research expenses by the amount of the Section 41 research credit claimed, or elect to take a reduced credit instead. This adjustment is treated as a change in accounting method, applied prospectively, without requiring retroactive corrections.

To support a smoother transition, the Act includes specific provisions for small businesses that meet the gross receipts test under Section 448(c). These businesses may retroactively apply Section 174A to tax years beginning after December 31, 2021, by amending prior returns or treating the change as a method adjustment.

Additionally, all taxpayers who incurred domestic research expenditures between 2022 and 2024 may elect to deduct the remaining unamortized balance over one or two tax years starting in 2025. This flexibility allows for more efficient recovery of previously capitalized costs and aligns with the broader goal of simplifying compliance and enhancing the utility of the research credit.

Revised Treatment of Business Interest Expense Under the OBBB Act

The One Big Beautiful Bill Act introduces several permanent changes to how business interest expense is calculated and deducted, particularly under Section 163(j). These updates aim to simplify compliance and offer greater clarity for businesses managing debt and capital investments.

• EBITDA-Based Deduction Framework Restored Starting with tax years after December 31, 2024, the calculation of adjusted taxable income (“ATI”) will once again include depreciation and amortization adjustments, effectively aligning ATI with EBITDA. This change allows businesses to deduct a larger portion of their interest expense, especially those with significant capital assets.
• Expanded Scope of Floor Plan Financing The definition of “motor vehicle” under the floor plan financing exception now includes trailers and campers designed for temporary living use. This expansion ensures that interest on financing for such inventory remains deductible, benefiting dealerships and retailers in the recreational vehicle sector.
• Exclusion of Certain Foreign Income from ATI Beginning in 2025, ATI will exclude specific foreign income components such as Net Controlled Foreign Corporation Tested Income (“NCTI”), Subpart F inclusions, Section 78 gross-ups, and related deductions. This adjustment narrows the base used to determine interest deduction limits, particularly for multinational entities.
• Clarified Treatment of Capitalized Interest The Act confirms that the Section 163(j) limitation applies to all business interest, whether deducted directly or capitalized. When interest is subject to capitalization, the allowable deduction is first applied to those amounts. However, interest capitalized under Sections 263(g) and 263A(f) remains outside the scope of this provision.

Permanent Extension of Excess Business Loss Limitation

• The One Big Beautiful Bill Act permanently extends the limitation on excess business losses for noncorporate taxpayers, effective for tax years beginning after December 31, 2026.
• Excess losses exceeding the annual threshold will be treated as net operating losses (NOLs) and carried forward to subsequent tax years without restriction to business income only.
• The Act also resets the limitation thresholds to $250,000 for single filers and $500,000 for joint filers, with inflation adjustments based on 2024 figures. These updated limits apply beginning January 1, 2026.

Updated Ownership Threshold for Taxable REIT Subsidiaries

Effective for tax years beginning after December 31, 2025, the One Big Beautiful Bill Act increases the allowable asset concentration in taxable REIT subsidiaries (TRSs). Real estate investment trusts (REITs) may now hold securities of TRSs representing up to 25 percent of their total assets at the close of each calendar quarter, up from the previous 20 percent limit.

This adjustment provides REITs with enhanced structural flexibility, enabling expanded subsidiary activities while maintaining compliance with existing REIT qualification requirements.

Revised Deduction Framework for Qualified Business Income

Beginning in tax years after December 31, 2025, the One Big Beautiful Bill Act introduces significant and enduring changes to Section 199A, aimed at enhancing accessibility and consistency for noncorporate taxpayers.

• The Act formalizes the 20 percent deduction for qualified business income (“QBI”), including earnings from REIT dividends, qualified publicly traded partnerships (“PTPs”), and specified cooperative activities. This rate differs from the 23 percent deduction proposed in earlier House legislation.
• Income phase-in thresholds have been expanded, allowing joint filers up to $150,000 and other filers up to $75,000 in taxable income before deduction limitations begin. This adjustment broadens eligibility for full deduction benefits.
• A guaranteed minimum deduction of $400 is introduced for taxpayers who materially participate in their businesses under Section 469(h) and generate at least $1,000 in QBI from active trades or businesses. This ensures baseline support for actively engaged individuals, even with modest earnings.
• Inflation indexing is recalibrated using 2024 as the base year, updating thresholds and deduction parameters to reflect more current economic conditions.
• The final legislation does not incorporate Business Development Company (BDC) interest dividends into the definition of qualified income, an element that was present in the House proposal but ultimately excluded from the Act.

PTET Treatment Under the OBBB Act

In response to the SALT deduction cap under the TCJA, many states adopted Pass-through Entity Tax (“PTET”) regimes, allowing partnerships and S corporations to pay state taxes at the entity level. The IRS affirmed this approach in Notice 2020-75, enabling deductions without applying the SALT cap at the individual level.

The One Big Beautiful Bill Act does not modify PTET provisions. Existing treatment remains in effect, subject to future Treasury or IRS guidance.

Long-Term Application of 24% Backup Withholding

Under IRC Section 3406, payors making reportable payments—commonly those disclosed on Form 1099—must obtain a valid U.S. Taxpayer Identification Number (TIN) from the recipient. If the recipient does not provide a TIN, backup withholding applies at a rate equal to the fourth-lowest individual income tax bracket under Section 1(c).

The Tax Cuts and Jobs Act (TCJA) temporarily set this rate at 24 percent through 2025. The One Big Beautiful Bill Act makes this rate permanent by extending the TCJA’s bracket structure indefinitely, preserving the 24 percent backup withholding rate beyond calendar year 2025.

Statutory Enhancements to ERTC Compliance and Claim Review

The One Big Beautiful Bill Act establishes several oversight provisions aimed at reinforcing accountability around Employee Retention Tax Credit (ERTC) claims tied to COVID-19 relief.

• Refund Claims Deadline Refund requests submitted after January 31, 2024, are no longer eligible. This marks a firm cutoff for retroactive filings.
• Extended Assessment Period The statute of limitations for evaluating certain ERTC claims has been expanded, granting the IRS additional time to review third- and fourth-quarter filings from 2021.
• Due Diligence Requirements for Promoters Individuals or entities offering ERTC-related services—classified as promoters—must meet specific due diligence obligations for Q3 2021 claims. Noncompliance results in a $1,000 penalty per failure.
• Criteria for Promoter Classification A person or firm is considered an ERTC promoter if they:
  
  • Earn compensation based on the value of ERTC claims and derive over 20% of their annual gross receipts from such services, or
  • Have gross receipts either exceeding 50% from ERTC-related activity or totaling at least $500,000 while also surpassing 20% of annual gross receipts.

ERTC Refund Deadlines and IRS Assessment Extension

Under the One Big Beautiful Bill Act, several provisions revise the treatment of Employee Retention Tax Credit claims related to the third quarter of 2021. Certified professional employer organizations are excluded from the definition of ERTC promoters and are not subject to the associated compliance penalties. Refund claims for Q3 2021 ERTC submitted after January 31, 2024, are no longer permitted, regardless of previous statutory timelines.

The Act also extends the IRS’s review period for Q3 2021 claims to six years. This window begins from the latest of the original quarterly return filing date, April 15 of the year following the calendar year in question, or the date the ERTC claim was made.

Additionally, taxpayers may file a refund claim for deductions denied due to disallowed Q3 2021 ERTC wages. These refund requests must be submitted within the same six-year review period.

Updated Employer Credit Thresholds for Child Care Assistance

The One Big Beautiful Bill Act incorporates legislative revisions to Section 45F as previously approved by the Senate and House. These changes apply to qualifying expenses incurred after December 31, 2025. Under the updated provision, the allowable employer credit for providing child care assistance is significantly increased. The annual cap rises from $150,000 to $500,000, while eligible small businesses may claim up to $600,000. Both thresholds will be adjusted annually for inflation to maintain their intended value over time.

Transition from GILTI to NCTI: Key Legislative Changes

The Act restructures the GILTI regime by removing the QBAI reduction and requiring inclusion of Net CFC Tested Income (NCTI). Beginning after December 31, 2025, the Section 250 deduction for NCTI and the related Section 78 gross-up is reduced to 40 percent. Foreign tax credits for NCTI are limited to 90 percent, with a 10 percent disallowance applied to taxes on distributions of previously taxed earnings and profits (PTEP). These changes result in an effective U.S. tax rate on NCTI between 12.6 and 14 percent.

These changes apply to taxable years of foreign corporations beginning after December 31, 2025. The disallowance of foreign taxes paid or deemed paid on distributions of previously taxed earnings and profits (PTEP) related to NCTI applies to distributions made after June 28, 2025.

For foreign tax credit limitation purposes, deductible amounts allocable to NCTI are limited to: (1) the Section 250 deduction, including taxes imposed under Section 164(a)(3), and (2) deductions directly attributable to the inclusion. Interest and research expenditures are excluded from NCTI allocation and instead assigned to U.S.-source income.

Finalization of TCJA Rate Reductions and Bracket Indexing Rules

The Tax Cuts and Jobs Act (TCJA) reduced the highest ordinary income tax rate from 39.6% to 37% for individuals, estates, and trusts—originally a temporary measure. The Act now makes this reduction permanent, maintaining the top bracket at 37%.

Income tax brackets remain subject to annual inflation adjustments. However, the Act selectively applies an additional year of inflation indexing to the thresholds for the 10%, 12%, and the starting point of the 22% brackets. This enhancement does not extend to the 35% and 37% brackets, which will continue to follow standard adjustment protocols.

Extension of Qualified Disaster Loss Provisions

The Act preserves taxpayer-favorable treatment for personal casualty losses that meet the criteria of Qualified Disaster Losses. Eligible taxpayers may deduct such losses without applying the 10% adjusted gross income (AGI) reduction typically required under standard rules.

These provisions remain applicable to disasters:

• Officially declared by the President no later than February 11, 2025
• Whose incident periods begin before December 12, 2024
• And conclude by January 11, 2025

While no substantive modifications were made to the prior Senate or House proposals, the Act effectively extends coverage. Certain disaster events occurring at the end of 2024 and the beginning of 2025 now fall within the statutory parameters and qualify under the updated definition of Qualified Disaster Losses.

Inclusion of State-Declared Disasters in Loss Relief

The Act formalizes the TCJA’s temporary limitation on itemized deductions for personal casualty losses, restricting deductibility to losses arising from Federally declared disasters. These include property losses unrelated to business or profit-driven activities, such as those caused by fire, storm, theft, or similar events.

Effective for tax years beginning after December 31, 2025, the Act expands eligibility to include “State Declared Disasters.” These are defined as natural catastrophes—such as fires, floods, or explosions—recognized jointly by the Governor of the affected state and the Secretary as warranting relief under the personal casualty loss provisions.

Standardization of Itemized Deduction Framework Post-TCJA

The Act solidifies the TCJA’s temporary repeal of miscellaneous itemized deductions—such as investment-related expenses, certain legal fees, and unreimbursed employee business costs— by making the repeal permanent.

Importantly, unreimbursed expenses incurred by eligible educators are excluded from this repeal. The Act ensures that qualified educator-related expenses remain deductible and are no longer categorized as miscellaneous itemized deductions.

Post-Enactment Modifications to Section 1202 Treatment

The Act codifies prior limitations under Section 1202, retaining the requirement that Qualified Small Business Stock (QSBS) be held for more than five years to qualify for the gain exclusion. The maximum exclusion remains the greater of $10 million—adjusted for prior exempted gains— or ten times the taxpayer’s aggregate adjusted basis in the disposed stock. The applicable exclusion percentage continues to depend on the stock’s issuance date, with a 100% exclusion applying to shares issued after September 27, 2010.

To qualify as QSBS, the issuing corporation must satisfy several criteria, including classification as a qualified small business under the gross asset threshold.

The Act introduces key changes to Section 1202, most notably:

• Establishment of a tiered exclusion framework based on holding period for QSBS acquired after July 4, 2025
• 50% exclusion for stock held three years
• 75% exclusion for stock held four years
• 100% exclusion for stock held five years or longer

Additionally, gain excluded under any tier is exempt from Alternative Minimum Tax (AMT) adjustments, streamlining compliance for eligible investors.

The Act increases the Section 1202 gain exclusion limit from $10 million to $15 million per issuer, with inflation adjustments beginning in 2027. This enhancement does not apply to taxpayers who have already utilized the full exclusion amount in prior years.

Additionally, the gross asset threshold for a corporation to qualify as a small business is raised from $50 million to $75 million, also subject to inflation indexing. These changes apply to Qualified Small Business Stock (QSBS) acquired on or after the date of enactment, with acquisition dates determined under Section 1223.

SALT Deduction Relief for Middle-Income Taxpayers

The Act temporarily increases the cap on the State and Local Tax (SALT) deduction to $40,000 for tax years 2025 through 2029, offering expanded relief to higher-income itemizers. For individuals filing separately, the cap is limited to $20,000 during this period. Beginning in 2030, the cap permanently reverts to $10,000 ($5,000 for separate filers).

In line with the House-passed bill, a phased reduction applies based on modified adjusted gross income (MAGI), beginning at $500,000 in 2025. Both the cap and phaseout threshold increase annually by 1% through 2029, with the deduction never falling below the $10,000 floor. All applicable limits and thresholds are halved for separate filers.

The Act does not alter the federal tax treatment of state and local taxes (SALT) imposed on passthrough entities. As a result, both elective Pass-Through Entity Taxes (PTET) and longstanding non-elective taxes—such as New York City’s Unincorporated Business Tax (UBT)— remain deductible at the entity level under current law.

However, the continued federal recognition of PTET regimes is based solely on IRS Notice 2020-75, which has not yet been codified. Accordingly, the deductibility of these taxes remains subject to future regulatory action by the Treasury Department. The SALT cap provisions introduced by the Act apply to taxable years beginning after December 31, 2024.

TCJA AMT Limits Made Permanent

The Act permanently extends the increased alternative minimum tax (AMT) exemption amounts and phase-out thresholds originally enacted under the TCJA. These provisions, which were set to expire after 2025, will now remain in effect beyond that date.

For inflation indexing purposes, the Act resets the reference year to 2025 rather than 2017. As a result, the exemption and phase-out thresholds applicable for 2026 will reflect the original 2018 TCJA values, without incorporating inflation adjustments from the intervening years. Indexation will resume from the new 2025 baseline.

The Act adopts key elements of the Finance Committee’s proposal by permanently extending the increased alternative minimum tax (AMT) exemption amounts and phase-out thresholds. Under this framework, the exemption figures will be inflation-adjusted from a 2017 base year, preserving cumulative adjustments made since the TCJA’s enactment.

Beginning in 2026, the phase-out thresholds will revert to the original 2018 levels—$500,000 for single filers and $1,000,000 for joint filers—with inflation indexing resuming in 2027. Notably, the Act deviates from current law by increasing the phase-out rate to 50% of alternative minimum taxable income exceeding the threshold, replacing the prior 2% reduction mechanism.

Temporary Deduction for Qualified Tips

The Act introduces a new above-the-line deduction for individuals receiving qualified tips in occupations where tipping is customary, applicable for tax years 2025 through 2028. This deduction is available even to those who do not itemize.

To qualify, the tip must be voluntarily paid, non-negotiable, and determined solely by the customer. Tips received in specified service trades or businesses, as defined under Section 199A(d)(2), are excluded. Additionally, individuals with earned income exceeding the threshold under Section 414(q)(1)(B)(i) are ineligible—though a 5% owner may qualify if their earned income falls below the limit.

A valid, work-eligible Social Security number is required to claim the deduction, and applicable payors must report qualified tips to the Secretary in prescribed informational statements.

The Act closely tracks the Finance Committee’s proposal with respect to the above-the-line deduction for qualified tips, but excludes the extension of the employer tip credit to beauty service businesses. The deduction is capped at $25,000 per year and is subject to a phased reduction of $100 for every $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 for joint filers). For this purpose, modified adjusted gross income includes adjusted gross income increased by any amounts excluded under Sections 911, 931, or 933.

Additionally, the Act expands the scope of eligible tip income by removing the exclusion tied to the compensation threshold under Section 414(q)(1)(B)(i). A transition rule applies to tax years beginning before January 1, 2026, permitting employers to use Treasury-prescribed estimation methods for reporting tip amounts.

Expanded Tip Reporting Obligations for Payors

The Act amends Sections 6041, 6041A, and 6050W to expand reporting obligations for payors issuing Forms 1099-K, 1099-MISC, or 1099-NEC in connection with service-related compensation. In addition to reporting total payment amounts—subject to applicable thresholds—payors must now:

• Separately identify the portion of payments attributable to cash tips, and
• Indicate the recipient’s occupation, as defined under Section 224(d)(1) of the One Big Beautiful Bill Act (OBBBA), which refers to roles where tipping was customary prior to December 31, 2024.

These modifications are intended to support the administration of the new above-the-line deduction for qualified tips and enhance transparency in tip-related income reporting.

Targeted Retention of Moving Expense Relief

The Act permanently repeals the above-the-line deduction for moving expenses incurred in connection with the commencement of employment at a new principal place of work, as well as the exclusion from gross income for employer-provided moving expense reimbursements. These changes align with the House-passed proposal and apply broadly, with exceptions retained for active-duty members of the Armed Forces.

In addition, the Act expands eligibility by extending both the deduction and the exclusion to certain members of the Intelligence Community who relocate due to a change in assignment. This provision recognizes the operational mobility requirements associated with national security roles.

The Act establishes Section 4475 under new Subchapter C of Subtitle D, Chapter 36 of the Internal Revenue Code, imposing a 1% excise tax on remittance transfers—defined as electronic fund transfers initiated by individuals in the United States to recipients located abroad.

The tax is imposed on the sender of the remittance, while the remittance transfer provider is responsible for collecting the tax at the time of transfer and remitting it to the Treasury on a quarterly basis. In the event of noncompliance, the provider becomes personally liable for the unpaid tax.

Additionally, remittance transfers that violate the anti-conduit rules under Section 7701(l) may be recharacterized as financing transactions for tax purposes.

Areas of Potential Federal-State Disconnect in Business Taxation

In fixed-date conformity states, several provisions of the Act may result in federal-state discrepancies unless specifically adopted at the state level. These areas of potential nonconformity include:

• Section 250 (GILTI and FDII deduction percentages) : Some states may retain prior deduction rates rather than adopting the updated federal percentages of 40% for GILTI and 33.34% for FDII beginning in 2026.
• Section 163(j) (limitation on business interest expense) : Certain jurisdictions may continue applying pre-2022 adjusted taxable income calculations that exclude addbacks for depreciation, amortization, and depletion.
• Section 174 (treatment of domestic research expenditures) : States may require continued amortization of research and experimental costs, despite federal changes permitting immediate expensing.
• Section 168(n) (expensing of qualified production property) : States may not conform to federal provisions allowing full expensing of qualified production real property under the new Section 168(n).

Impact of July 4, 2025 Tax Reform on Deferred Tax Accounting

In accordance with ASC 740, entities are required to recognize the effects of newly enacted tax legislation within the interim and annual reporting periods that include the enactment date.

Changes in tax law affecting deferred tax assets and liabilities as of the enactment date must be recognized in continuing operations and treated as a discrete item in the period of enactment. In contrast, income tax effects on current taxes attributable to current-year ordinary income are incorporated into the annual effective tax rate beginning in the enactment period. Similarly, deferred tax effects arising after the enactment date that relate to ordinary income are also included in the annual effective tax rate from the period in which the law takes effect.

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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 [email protected]

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

Disclaimer: Section 1202 was amended as part of the One Big Beautiful Bill Act signed into law on July 4, 2025. Information contained in this article has not yet been updated and is therefore not current.

Introduction

The §1202 exclusion under the Internal Revenue Code offers a powerful and often overlooked tax incentive for investors and founders of startups and small businesses structured as C corporations. Especially relevant in mergers and acquisitions (M&A), this provision allows for significant (and sometimes total) exclusion of gain on the sale of qualified small business (“QSB”) stock, making it a critical strategic consideration in corporate transactions.

What Is the §1202 Exclusion?

Section 1202 of the Internal Revenue Code provides that non-corporate taxpayers (individuals, trusts, or estates) may exclude up to 100% of the gain from the sale or exchange of QSB stock held for more than five years.

The percentage of the exclusion depends on the acquisition date of the stock:

• 100% exclusion: For stock acquired after September 27, 2010
• 75% exclusion: For stock acquired after February 17, 2009, but before September 28, 2010
• 50% exclusion: For stock acquired before February 18, 2009
• The maximum amount of gain eligible for exclusion per taxpayer per issuer is limited to the greater of: $10 million, or 10 times the taxpayer’s adjusted basis in the QSB stock.

Eligibility Requirements for QSB Stock

Shareholder-Level Requirements

1. Eligible Shareholder

To qualify, the stock must be held directly or indirectly by an eligible shareholder, which includes individuals, trusts, and estates — all non-corporate taxpayers. If the shareholder is a partnership or an S corporation, the gain may still qualify under Section 1202. However, additional requirements must be met to enable the pass-through entity’s owners to claim the exclusion. Partnerships, in particular, can introduce complexities that might reduce the benefit unless structured carefully to preserve Section 1202 eligibility.

2. Holding Period

The stock must be held for more than five years prior to disposition. Generally, the holding period begins on the date of issuance. If stock is issued in exchange for non-cash property, the Section 1202 holding period still starts on the exchange date, even if a different holding period applies for other tax purposes. If stock is issued through the conversion of debt, or the exercise of options or warrants, the holding period begins at the time of conversion or exercise. Certain hedging transactions may disqualify the stock from Section 1202 treatment. In some cases, the shareholder can “tack on” a previous owner’s holding period — such as stock acquired by gift, inheritance, certain partnership distributions, or through specified stock conversions and exchanges.

3. Original Issuance Requirement

The taxpayer must have acquired the stock upon original issuance directly from the corporation after August 10, 1993. Stock must be purchased from the company, not a secondary shareholder. Stock received as compensation for services qualifies. Stock issued in corporate reorganizations (e.g., exchanges) may also qualify under additional specific conditions. Stock transferred by gift or inheritance maintains the original holder’s Section 1202 eligibility.

Corporation-Level Requirements

4. Eligible Corporation

The issuing entity must be an eligible domestic C corporation at the time of issuance and throughout substantially all of the shareholder’s holding period. Certain corporations are excluded, including IC-DISCs, former DISCs, RICs, REITs, REMICs, and cooperatives. An LLC electing to be taxed as a C corporation qualifies. The corporation must be based in the United States, although its operational activities can be domestic or international.

5. $50 Million Gross Assets Limitation

At the time of stock issuance (and prior to issuance), the corporation’s aggregate gross assets must not exceed $50 million, measured by adjusted tax basis. This asset test is only measured at the time of issuance and is not reevaluated later. A corporation may subsequently grow beyond $50 million in assets without affecting prior issuances of QSB stock. Importantly, assets contributed to a corporation are valued at their fair market value at the time of contribution (such as in an LLC-to-corporation conversion), not their tax basis.

6. Redemption Transactions

Section 1202 disqualifies stock if it is issued around the time of a significant redemption by the corporation. Redemptions occurring one year before or after the issuance may disqualify stock if deemed significant.

• A redemption of as little as 5% of the stock may be considered significant.
• Redemptions involving related parties lower the threshold to 2% and expand the testing period to two years. Certain redemptions — such as those arising from death, disability, or service termination — may qualify for exceptions.
  

7. Qualified Trade or Business Requirement

The corporation must be engaged in a qualified trade or business. Activities in certain industries including professional services, finance, farming, mining, hospitality, and others are disqualified. There is limited official guidance on interpreting prohibited industries, leaving some flexibility and risk in taxpayer positions.

8. Active Business Requirement

During substantially all of the taxpayer’s holding period, the corporation must use at least 80% of its assets (by fair market value) in the active conduct of a qualified trade or business. Key points include:

• No more than 50% of the corporation’s assets may be held as working capital, unless intended to support operations or R&D activities.

Automatic disqualification occurs if:

• More than 10% of net assets are in passive stock/securities of corporations the issuer does not control (>50%); or
• More than 10% of gross assets are in non-operating real estate. These thresholds are based on fair market value, meaning unexpected fluctuations in investment holdings or real estate values can cause inadvertent disqualification.

Relevance of §1202 in M&A Transactions

In the M&A context, Section 1202 exclusion presents major strategic tax planning opportunities:

• Maximizing After-Tax Proceeds: Sellers who meet the §1202 requirements can potentially avoid federal capital gains taxes entirely (up to the exclusion limits). This dramatically increases after-tax proceeds compared to a conventional sale taxed at long-term capital gains rates.
• Structuring Deals to Preserve QSB Status: If a merger or acquisition involves a stock-for-stock exchange, care must be taken to preserve the five-year holding period and QSB status through ‘qualified transactions’ under §1202(h).
• Planning for Stock Redemptions or Buybacks: Stock redemptions by the corporation within certain periods can disqualify stock from §1202 treatment. Parties must analyze historical and planned redemptions during due diligence.
• Entity Choice for Startups and Emerging Companies: Founders anticipating an eventual exit via sale can be strongly incentivized to form and maintain their companies as C corporations to make future QSB gains eligible for §1202 exclusion.
• Rollovers and Deferrals Using §1045: If a shareholder sells QSB stock before satisfying the five-year holding requirement, §1045 allows the taxpayer to defer the gain by rolling over proceeds into new QSB stock within 60 days, preserving eligibility for future §1202 exclusion.
  

Key Challenges and Planning Considerations

Documentation Is Critical: Proof of original issuance, active business qualification, and asset tests must be properly documented and maintained.

Due Diligence During M&A: Buyers should assess whether §1202 qualification applies when determining purchase price allocations and negotiating indemnities.

State Tax Treatment: Not all states conform to the federal §1202 exclusion, which could result in state-level capital gains tax.

Takeaway

The Section 1202 gain exclusion is a powerful tool to promote entrepreneurship, investment in small businesses, and efficient structuring of M&A exits.

Proper planning at the entity formation stage, throughout the company’s life cycle, and during exit transactions can unlock tremendous tax benefits for founders, employees, and early-stage investors. Given its complexity and significant value, companies and founders must work with competent tax counsel and carefully navigate the requirements and opportunities afforded by §1202.

The Alternative Minimum Tax (AMT) was introduced in the United States in 1969 to ensure that high-income taxpayers contributed a minimum amount of tax, thereby precluding them from significantly reducing or eliminating their tax liability through the regular tax system. Similarly, the Corporate Alternative Minimum Tax (CAMT) was first instituted under the Tax Reform Act of 1986 to achieve a parallel objective for corporations.

In 2022, CAMT was reintroduced under the Inflation Reduction Act. This updated version encompasses more detailed and intricate provisions, reflecting a modernized approach to maintaining tax compliance among corporations.

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Introduction of the New CAMT and Its Impact

The revised Corporate Alternative Minimum Tax (CAMT) enforces a 15% minimum tax on the Adjusted Financial Statement Income (AFSI) of large corporations with a three-year average annual AFSI exceeding $1 billion. This tax is applicable for tax years commencing after December 31, 2022.

This change marks a significant departure from the previous CAMT, as it is now based on AFSI rather than taxable income. The updated CAMT considers income that meets the threshold over a three-year period. Financial statement income is typically higher than taxable income due to the limited inclusion of tax deductions and credits.

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CAMT Impact on Private Equity

The proposed regulations facilitate the aggregation of entities not traditionally consolidated in financial statements, such as portfolio companies controlled by private equity funds engaged in a trade or business, under the Corporate Alternative Minimum Tax. Subsidiaries of private equity funds not engaged in a trade or business are not explicitly included, and commenters suggest they should not be aggregated without further guidance, which is anticipated upon finalization of the regulations. This single entity rule could result in more blockers or public companies utilizing Up-C structures being classified as “applicable corporations” if their group meets the $1 billion threshold for Adjusted Financial Statement Income.

The regulations apply the constructive ownership rules under IRC Section 1563(d)(1)(B) to attribute control through partnerships. Consequently, private equity funds’ indirect ownership of portfolio companies could count towards the CAMT threshold, increasing the likelihood of exceeding the $1 billion threshold. For instance, a private equity fund with a foreign partnership owning both foreign and domestic blocker corporations, each owning a domestic portfolio company, would see these portfolio companies included in the Foreign Parented Multinational Group (FPMG) since they are part of the same single employer group as the blockers. This broader group could potentially meet the threshold for applicable corporation status.

The Corporate Alternative Minimum Tax (CAMT) introduces considerable complexity for private equity funds by necessitating the calculation and reporting of Adjusted Financial Statement Income (AFSI) for their entire group, encompassing both foreign and domestic entities. Private equity funds may be required to consolidate financial data from a diverse array of investments, even those not traditionally consolidated for financial reporting purposes. This comprehensive approach has the potential to impact the overall tax liability of the fund.

Furthermore, the Treasury’s proposed bottom-up approach is anticipated to significantly increase the workload for partnerships and corporations holding partnership interests. Partnerships will need to calculate their AFSI and ensure precise reporting to their CAMT entity partners upon request. Such requests must be addressed within 30 days of the end of the partnership’s tax year, particularly if the CAMT entity partner cannot ascertain its distributive share of the partnership’s AFSI without this information.

When requested by a CAMT entity partner, a partnership is obligated to furnish it to the CAMT entity partner. Once a request is made, the partnership must continue to supply the information for each subsequent taxable year unless otherwise notified. An upper-tier partnership must request the relevant information from a lower-tier partnership, which must file the information with the IRS and provide it to the upper-tier partnership.

This intricate process could significantly increase the compliance burden, prompting investment funds to carefully consider accepting subscriptions from entities potentially subject to CAMT. Consequently, partnerships may need to maintain four distinct sets of records:

a. financial accounting;

b. tax basis;

c. IRC Section 704(b) economic capital accounts; and

d. CAMT

Tax professionals and stakeholders have recommended that the Treasury implement safe harbors or simplified methods to alleviate the reporting burden, particularly for companies holding minority stakes in partnerships. Without such simplifications, many entities could experience a substantial increase in their compliance workload.

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Adapting to CAMT

Corporate tax departments must have a comprehensive understanding of the new Corporate Alternative Minimum Tax (CAMT) rules and their implications under the Inflation Reduction Act. In 2023, the IRS provided consistent guidance to clarify various aspects of CAMT. The September guidance offered detailed instructions on determining a company’s financial statement income and Adjusted Financial Statement Income (AFSI), and outlined the circumstances under which corporations are subject to CAMT. This includes CAMT foreign tax credits, tax consolidated groups, foreign corporations, depreciable property, wireless spectrum, duplications and omissions of certain items, and financial statement net operating losses.

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CAMT’s Impact on Corporate Tax Liabilities

For businesses meeting the $1 billion threshold, it is imperative to review tax liabilities comprehensively. Corporate tax leaders must analyze both regular taxable income and financial statements. CAMT liability is determined by applying a flat tax rate to adjusted income, which includes adding back certain tax preference items and making necessary adjustments. If the CAMT liability exceeds the regular tax liability, the company must pay the CAMT amount. This can limit the benefits of deductions and credits, potentially resulting in a higher tax bill. The impact will vary based on the company’s financial situation, use of deductions and credits, and any changes in tax legislation.

The CAMT imposes limitations on the utilization of tax credits and net operating losses (NOLs), impacting deferred tax assets (DTAs) and liabilities reported on financial statements. This can diminish the availability of future tax benefits and affect cash flow projections, necessitating adjustments to long-term tax planning strategies. Ensuring compliance with SEC and IRS regulations is vital to maintaining accurate financial reporting, avoiding legal penalties, and upholding investor trust. Non-compliance can result in audits, fines, and reputational damage, ultimately affecting stock value and stakeholder confidence.

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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 [email protected]

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

The Treasury and the IRS have issued final regulations under Section 861 (the “2025 final regulations”), addressing transactions involving “digital content” and certain “cloud transactions.” For these purposes:

• Digital content refers to computer programs or other materials—such as books, movies, and music—provided in digital format. This includes content protected by copyright law, or content that has entered the public domain due to the expiration of copyright protection or a creator’s dedication of the material to the public domain.
• Cloud transactions involve obtaining on-demand network access to computer hardware, digital content, or similar resources.

These regulations primarily affect taxpayers involved in digital content or cloud transactions. They will take effect for taxable years beginning on or after their publication date in the Federal Register, currently scheduled for January 14, 2025.

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The 2025 final regulations generally align with the framework established in the 2019 proposed regulations, incorporating several revisions. Key updates include:

1. Replacing certain de minimis rules with a “predominant character” rule for classifying transactions with multiple components.
2. Using the purchaser’s billing address, rather than the “place of sale,” “title passage,” or place of download, to source income from sales of copyrighted articles via digital platforms that are not governed by Section 863(b).
3. Characterizing all cloud transactions exclusively as services transactions, eliminating the multifactor “services vs. lease” test outlined in the 2019 proposed regulations.

In addition, Treasury and the IRS have published proposed regulations (Proposed Regulations) to clarify the sourcing of income from cloud transactions. These Proposed Regulations aim to provide taxpayers with greater certainty and facilitate IRS audits. Taxpayers earning gross income from cloud transactions will be impacted. Public comments on the Proposed Regulations are due within 90 days of their publication in the Federal Register, currently expected on January 14, 2025.

The Proposed Regulations introduce a taxpayer-specific approach for sourcing income from cloud transactions, focusing on the economic contributions made by intangibles, employees, and assets involved in performing the cloud transaction. They also outline a mathematical formula to determine the source of such income, factoring in:

1. The intangible property contribution,
2. The personnel contribution, and
3. The tangible property contribution.

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Finally, the IRS has released Notice 2025-6, soliciting comments on the potential implications of extending the characterization rules in Regulations 1.861-18 and 1.861-19, as amended by the 2025 final regulations, to all provisions of the Internal Revenue Code. Currently, the 2025 final regulations apply only to specific international provisions of the Code, as detailed within the regulations.

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The 2025 final regulations finalize Proposed Regulation 1.861-18, extending the income classification rules for computer programs to other forms of digital content and updating certain existing rules for characterizing income. Additionally, the final regulations finalize Proposed Regulation 1.861-19, offering guidance on how to characterize income from transactions involving on-demand network access to computer hardware, digital content, and similar resources.

The Proposed Regulations emphasize the need for specific sourcing rules to address the unique nature of income from cloud transactions. These regulations would take effect for tax years beginning on or after the publication of the final rules in the Federal Register.

For more information on the impact of these rules on your transactions or business, feel free to reach us at [email protected]

On December 23, 2024, the Tax Court reaffirmed its interpretation of the “limited partner exception” to self-employment tax under section 1402(a)(13) of the Internal Revenue Code in Denham Capital Management LP v. Commissioner (T.C. Memo. 2024-114).

This decision echoes its earlier ruling in Soroban Capital Partners LP v. Commissioner (161 T.C. No. 12) and has broader implications for active limited partners in state law limited partnerships.

This article examines the legal background, the Soroban case, and the facts and findings of the Denham Capital case, along with related pending cases that challenge these interpretations.

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Background

Under IRC Section 1402(a), net earnings from self-employment are generally subject to self-employment tax. However, Section 1402(a)(13) provides an exception for the distributive share of income received by a limited partner—excluding guaranteed payments for services rendered.

Congress intended this exception to shield passive investors in partnerships from self-employment tax. However, over time, disputes have arisen over whether individuals who actively participate in the management or operations of partnerships qualify for the “limited partner exception.”

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Soroban Capital Partners LP v. Commissioner (161 T.C. No. 12)

Facts of Soroban Capital

Soroban Capital Partners LP, a state law limited partnership was engaged in investment management. Several of its partners were designated as limited partners under state law but were actively involved in the partnership’s day-to-day operations, including management and decision-making.

Court’s Findings

The Tax Court ruled that these partners did not qualify for the “limited partner exception” to self-employment tax because:

1. Their roles were active and managerial, rather than passive.
2. The “limited partner” designation under state law does not control for purposes of applying federal tax law.

Instead, the Court applied a functional analysis, emphasizing the nature of the work performed rather than formal titles.

Key Takeaway

The Soroban decision established a precedent that active involvement in a partnership’s business activities disqualifies partners from claiming the limited partner exception to self-employment tax, even if they are designated as limited partners under state law.

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Denham Capital Management LP v. Commissioner (T.C. Memo. 2024-114)

Facts of Denham Capital

Denham Capital Management LP, similar to Soroban, was organized as a state law limited partnership involved in investment management. Its limited partners actively participated in:

• Strategic decision-making
• Managing investments
• Supervising day-to-day operations

The IRS assessed self-employment tax on the distributive shares allocated to these limited partners, which the taxpayers disputed, relying on their limited partner designation under state law.

Court’s Findings

The Tax Court reaffirmed the Soroban ruling, emphasizing that:

1. State law designations do not override federal tax law.
2. Partners who actively participate in a partnership’s operations are not passive investors.
3. A functional test applies, focusing on the substance of the partner’s role rather than formal titles.

Implications

The Denham decision strengthens the IRS’s position that active limited partners cannot use the limited partner exception to avoid self-employment tax, increasing compliance requirements for partnerships with active participants.

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Related Cases: Sirius Solutions and Point72 Asset Management

Sirius Solutions LLLP v. Commissioner (Docket No. 30118-21)

Sirius Solutions challenged the Soroban interpretation and is appealing the Tax Court’s similar ruling to the Fifth Circuit Court of Appeals. This case could potentially lead to a circuit split, adding uncertainty to the application of Section 1402(a)(13).

Point72 Asset Management, L.P. v. Commissioner (Docket No. 12752-23)

Point72 remains in Tax Court and raises similar arguments about the definition of “limited partner.” Its outcome could either reinforce or challenge the Soroban precedent.

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Broader Impact and Future Considerations

The Denham and Soroban decisions highlight a growing judicial trend to look beyond state law labels and focus instead on functional roles in determining tax obligations. Key considerations include:

1. Active Participation – Any partner performing managerial or operational roles faces greater scrutiny.
2. Entity Structuring – Partnerships may need to revisit their operating agreements and consider alternative structures.
3. Compliance Risks – Taxpayers should prepare for IRS audits and litigation risks if relying on the limited partner exception.
4. Legislative Clarification – Congress may eventually issue guidelines under Section 1402(a)(13) to provide clearer guidance on what constitutes a “limited partner.”

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The reaffirmation of Soroban in Denham Capital Management LP v. Commissioner represents a significant step in resolving disputes over the limited partner exception to self-employment tax. With Sirius Solutions and Point72 still pending, the issue remains contentious, and practitioners should closely monitor these developments.

For partnerships with active participants, these rulings emphasize the need for careful tax planning and documentation to mitigate risks of adverse IRS determinations. Consulting tax professionals and legal advisors is highly recommended to navigate this complex and evolving area of tax law.

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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 [email protected]

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

On December 18, 2024, Representative Darin LaHood, a member of the House Committee on Ways and Means, introduced the Residence-Based Taxation for Americans Abroad Act, a bill that would implement a residence-based taxation system for U.S. citizens currently living overseas. The legislation seeks to transition from the current citizenship-based taxation system to a residence-based taxation model, aligning the U.S. with the tax practices of other major countries.

Similar bills/initiatives have been proposed in the past. However, this legislative effort aligns with President-elect Donald Trump’s campaign promise to eliminate U.S. income taxes for Americans living abroad, marking a significant shift in U.S. tax policy. These efforts reflect growing awareness of the unique challenges faced by American expats. Comprehensive reforms have yet to be implemented.

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Key Provisions of the Bill

Residence-Based Taxation Election:

The bill allows U.S. citizens residing abroad to opt into a residence-based taxation system. Under this system, expatriates would be taxed solely by their country of residence on foreign income, exempting them from U.S. taxes on such income. However, they would remain liable for U.S. taxes on income sourced within the United States, as is the case for majority of the countries following source-based tax system.

Departure Tax for Wealthy Individuals:

To prevent tax avoidance by high-net-worth individuals, the bill introduces a “departure tax.” The proposed tax would apply to those with a net worth exceeding the estate tax threshold (currently $13.61 million) who choose to switch to the residence-based system. It effectively treats all their assets as if sold before the transition, ensuring the U.S. collects taxes on unrealized gains.

Exemptions from Departure Tax:

Under the proposal, certain expatriates can avoid the departure tax, including:

• Individuals who haven’t lived in the U.S. since turning 25 or since March 2010.
• Those who have resided abroad for at least three of the past five years and have complied with U.S. tax laws.

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Contextual Background

The current U.S. tax system requires citizens to file returns on worldwide income, regardless of residence, leading to complex compliance burdens, especially for middle-income Americans abroad. The United States stands alone among major nations in employing a citizenship-based taxation system, imposing taxes on individuals regardless of their residence or whether they earn income within the U.S. This proposed legislation would grant Americans residing abroad the option to be classified as non-resident Americans, subjecting them to U.S. taxes solely on income and gains derived from U.S. sources.

Recent estimates suggest that over 5 million U.S. citizens are currently residing abroad. This population includes Americans who were born and raised in the United States but have chosen to live overseas indefinitely, as well as “accidental Americans”—individuals with dual U.S. and foreign citizenship who may be unaware of their U.S. citizenship status.

In recent years, this issue has gained increasing attention and was a key priority for President-elect Trump during his campaign. In an October interview with The Wall Street Journal, President Trump expressed his support for reform, stating, “I support ending the double taxation of overseas Americans.”

“This is a non-partisan issue that impacts U.S. citizens with ties to districts across the country,” said Representative Darin LaHood. “In today’s interconnected world, many Americans choose to live and work abroad for a variety of reasons. They should not be subjected to excessive tax and compliance burdens for doing so. I look forward to collaborating with President-elect Trump and my colleagues on both sides of the aisle to modernize our tax code and ensure Americans abroad are treated fairly.”

“For the first time in decades, Americans living abroad can see a potential resolution to the significant challenges they’ve faced, including costly compliance fees, strained personal relationships, and the inability to live normal lives,” said Brandon Mitchener, Executive Director of Tax Fairness for Americans Abroad (TFFAA). “We deeply appreciate Rep. LaHood’s leadership and are eager to work with him to gather feedback and advance this bipartisan legislation to the president’s desk next year.”

Rep. LaHood collaborated closely with TFFAA in drafting the bill. TFFAA is a U.S.-based non-profit organization whose board members have firsthand experience navigating the complex U.S. tax and financial regulations that impact Americans abroad. The organization’s mission is to advocate for a tax system that bases taxation on residence and source, rather than citizenship.

The introduction of this bill marks an important opportunity for stakeholders and Americans abroad to provide feedback before its reintroduction in the 119th Congress. Rep. LaHood remains optimistic that the bill will be included in a reconciliation package next year.

Expatriate advocacy groups have expressed support for the proposal, highlighting its potential to reduce administrative burdens and financial strains on Americans living overseas. Representative LaHood is seeking bipartisan backing and public feedback to refine the bill, ensuring it addresses revenue considerations and effectively serves the expatriate community.

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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 [email protected]

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