The following is an interesting question that

Transcription

1 May June 2011 Private Equity & Hedge Fund Corner By Joseph J. Bergthold and Thomas C. Lenz 1 How Private Equity Fund Managers Can Cash in on Tax Benefits of Qualified Small Business Stock Thomas C. Lenz is a Managing Director in the Financial Services Grou of RSM McGladrey, Inc. Joseph J. Bergthold is a Director in the Financial Services Group of RSM McGladrey, Inc. The following is an interesting question that could be posed to a fund manager: Would you like to be able to tell your investors that not only was your recent exit a smashing success, but they will pay little to no tax on the gain? Undoubtedly, the answer would be yes. The recent enactment of the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010 ( Tax Relief Act of 2010 ) 2 extends for two years a tremendous planning opportunity for private equity funds that invest in qualified small businesses. A fund investing in qualified small businesses can potentially exclude 100 percent of the gain recognized on the disposition of qualifying small business stock (QSBS). If the current revamped provisions of Code Sec do not apply, do not fret this Code Section has been in existence for almost two decades, and depending upon the acquisition date and holding period of the fund s portfolio company investment, a Fund may still benefit from Code Sec In this column, we will highlight the benefits and planning opportunities a fund manager and its investors can receive from this often overlooked Code Section. Overview History of Code Sec With the U.S. economy struggling its way out of a recession that hit many of the world economies in the early 90s, Congress and President Clinton sought a remedy to help stimulate economic growth. Their efforts led to the enactment of the Omnibus Budget Reconciliation Act of 1993 ( OBRA-93 ). 3 Included in OBRA-93 was Code Sec. 1202, which JOURNAL OF PASSTHROUGH ENTITIES 27

2 Private Equity and Hedge Fund Corner was Congress solution to help stimulate investment in small businesses. At the time, the Code Sec. allowed noncorporate investors to exclude 50 percent (60 percent if the corporation is located in a federal empowerment zone) of the capital gains on their investments in qualified small business stock. The 50-percent gain exclusion benefit of this Code Sec. has remained in place for almost two decades, until recent legislation significantly improved the benefit an investor in QSBS can receive. Code Sec Revisited With the more recent struggles of the U.S. economy, Code Sec was called on again to provide an incentive to invest in small businesses. The American Recovery and Reinvestment Act of 2009 ( ARRA ) 4 increased the gain exclusion to 75 percent for qualified small business stock acquired after February 17, 2009, and before January 1, Congress yet again revisited Code Sec in the Small Business Jobs Act of 2010 ( Small Business Jobs Act ) signed by the President on September 27, Two significant law changes were introduced with the bill. First, the 75-percent gain exclusion introduced in ARRA would increase to 100 percent for QSBS acquired after September 27, 2010, and before January 1, The second significant change to the Code Sec. was that the gain on QSBS qualifying for the 100-percent exclusion will not produce any alternative minimum tax (AMT) preference item. The great tax compromise, known as the Tax Relief Act of 2010, was signed by President Obama on December 17, While the primary focus of the bill was on extending the Bush-era tax cuts and unemployment relief, Code Sec again made an appearance. Building on law changes introduced in the Small Business Jobs Act in September, the new bill extended the 100-percent gain exclusion and AMT preference relief for one more year, for stock acquired before January 1, In spite of the gain from QSBS being subject to a 28-percent capital gain rate (to the extent the gain is not excluded from tax), significant planning opportunities are available to take advantage of the Code Sec gain exclusion. The amount of gain that can be excluded is dependent upon the window in which the QSBS was acquired, as well as other requirements discussed later in this column. Further, the negative impact of the AMT that contributed to the benefits of the Code Sec. being overlooked by tax practitioners has been temporarily removed. Lastly, it is important to understand the potential benefits available for QSBS acquired prior to the 100-percent exclusion window. While the benefit of the partial exclusion amount may be diminished by the impact of the 28-percent rate on QSBS and AMT, one must also consider the potential state tax savings. An investor may receive significant tax savings if the investor resides in a high-income-taxrate state, assuming state tax law conforms to federal tax law with respect to Code Sec What is the Gain Exclusion Amount? In the case of a taxpayer, other than a corporation, gross income excludes up to 100 percent of any gain from the sale or exchange of qualified small business stock held for more than five years. In the case of a taxpayer, other than a corporation, gross income shall not include 50 percent of any gain from the sale or exchange of qualified small business stock held for more than five years. 7 Depending upon the acquisition date of the qualifying stock, 50 percent shall be replaced by 75 percent or 100 percent. In other words, a taxpayer may exclude up to 100 percent of the gain from income on the disposition of QSBS. Special exclusion percentages apply to businesses that qualify as empowerment zone businesses. No election is required by the taxpayer in order to receive the benefit as the exclusion will apply automatically if the requirements are met. To help illustrate the different exclusion rates available based on the acquisition dates of qualifying stock, please refer to following table (refer to table T-1). Example 1. C Corporation, a qualified small business, issued common stock. T, an individual, paid $1,000 in cash to C Corporation for 100 shares of the stock. T holds the stock for five years and sells the shares for $2,000. T has a $1,000 realized gain on the sale of the stock. However, T must recognize only 50 percent of the gain, i.e., $500. The other 50 percent is excluded from gross income. Note that the $500 of long-term capital CCH. All Rights Reserved.

3 May June 2011 gain that must be reported will be taxed subject to a maximum rate of 28 percent. 8 Per-Issuer Limit on Taxpayer s Gain Eligible for Partial or Full Exclusion The total amount of gain that an eligible taxpayer may use in computing the exclusion amount may be limited. 9 The limitation on the gain that may be taken into account for purposes of Code Sec. 1202(a) for the tax year shall not exceed the greater of: $10,000,000, reduced by the aggregate amount of eligible gain taken into account by the taxpayer for prior tax years and attributable to dispositions of stock issued by such corporation 10 or 10 times the aggregate adjusted basis of qualified small business stock issued by such corporation and disposed of by the taxpayer during the tax year. Example 2. C Corporation, a qualified small business, issued 1,000 shares of common stock. T, an individual, purchased all of C Corporation s stock for $200,000. T holds the shares of common stock for five years and sells 500 shares of the stock for $7 million. T may use the entire $6.9 million (i.e., $7 million proceeds less one-half the $200,000 of total basis) of gain in computing its exclusion amount, even though the gain is more than 10 times T s basis in the shares, as the total gain is not more than $10 million. Example 3. Assume the same facts as in Example 2, and also assume T sells the other 500 shares of C Corporation common stock in the subsequent tax year for $10 million. T s total realized gain is $9.9 million (i.e., $10 million proceeds less $100,000 basis). However, T may use only $3.1 million of the gain in computing the exclusion amount under Code Sec. 1202, as T used $6.9 million of the gain from the sale of C Corporation common stock in a preceding tax year in computing T s Code Sec exclusion amount. Special Provisions for Married Individuals In the case of a separate return by a married individual, $5 million replaces $10 million, and for purposes of a joint return, the amount of eligible gain taken into account for purposes of computing the exclusion amount is allocated equally between the spouses for purposes of applying the limitation to subsequent tax years. 11 What Are the Requirements? In order to qualify for gain exclusion, the stock must be qualifying small business stock. Code Sec. 1202(c) defines QSBS as any stock in a C corporation, which as of the date of issue is: stock of a C corporation that is a qualified small business, and such stock is acquired by the taxpayer at its original issue (directly or through an underwriter). 12 Qualified Small Business Stock in a corporation is not treated as a QSBS unless the corporation is an eligible corporation, the corporation passes the gross assets test and for substantially all of the taxpayer s holding period of the stock, such corporation meets the active business requirement. In other words, ownership of shares in an S corporation will not qualify for purposes of Code Sec In addition, the C corporation cannot be one of the following entities 13 : Table T-1 Qualifying Criteria: 50% Gain Exclusion 75% Gain Exclusion 100% Gain Exclusion Effective Dates: QSBS acquired pre-february 18, 2009, and post December 31, 2011 QSBS acquired February 18, 2009, through September 27, 2010 QSBS acquired after September 27, 2011, through December 31, 2011 Corporation Size Limit Limit on Benefit Gross assets do not exceed $50 million 50% of exclusion on gain up to greater of $10 million or 10 times basis Gross assets do not exceed $50 million 75% of exclusion on gain up to greater of $10 million or 10 times basis Gross assets do not exceed $50 million 100% of exclusion on gain up to greater of $10 million or 10 times basis Holding Period Greater than 5 years Greater than 5 years Greater than 5 years Subject to AMT Yes, a portion of the gain exclusion is a preference item for minimum tax purposes Yes, a portion of the gain exclusion is a preference item for minimum tax purposes No, Gain exclusion is not a preference item for minimum tax purposes JOURNAL OF PASSTHROUGH ENTITIES 29

4 Private Equity and Hedge Fund Corner a DISC or former DISC; a regulated investment company; a real estate investment trust; a real estate mortgage investment conduit; a cooperative; or a corporation electing the Puerto Rico and possessions tax credit or having a direct or indirect subsidiary so electing Gross Asset Test In addition to being an eligible corporation, a C corporation must also pass a gross assets test in order to qualify as a qualifying small business. An eligible C corporation shall be deemed to satisfy the gross assets test if the aggregate gross assets of such corporation, or any predecessor thereof, at all times on or after the date of enactment of the OBRA-93 and before the issuance did not exceed $50,000,000; the aggregate gross assets of such corporation immediately after issuance do not exceed $50,000,000; and such corporation agrees to submit such reports to the Secretary and to shareholders as the Secretary may require. 14 Code Sec defines the term aggregate gross assets as the amount of cash and the aggregate adjusted basis of other property held by the corporation. 15 For purposes of determining the adjusted basis of contributed property to the corporation, the adjusted basis of such contributed property is determined as if the basis of the property contributed to the corporation were equal to the fair-market value at the time of the contribution. Note that if the corporation subsequently exceeds the $50 million asset limit, this will not disqualify otherwise qualifying stock, but any subsequent issuance of stock by the corporation will not be qualifying small business stock. Corporations which are members of a parent-subsidiary controlled group 16 are treated as one corporation for purposes of applying the gross asset test. 17 Example 4. C Corporation was created on September 1, At that time, T, an individual, contributed $5 million in cash to the corporation. By September 1, 2006, C Corporation s gross assets had increased to $25 million, the highest amount in the corporation s history. C Corporation, which is not a member of a parentsubsidiary controlled group, issued additional stock on September 1, 2006, to T for $10 million. Assuming C Corporation satisfies the other necessary requirements to be a qualified small business, the additional stock issued by C will also be QSBS. Now assume C Corporation has continued success and the gross assets of C Corporation exceed $50 million, the characterization of the stock issued in 2003 and 2006 will not be affected, and T will be eligible for the gain exclusion assuming T holds the stock for the five-year holding requirement. However, C Corporation will no longer be able to issue additional stock that will qualify as QSBS. Active Business Requirement The corporation must also meet the active business requirement. An eligible corporation is deemed to have met the active business requirement if at least 80 percent of the value of the corporation s assets is used by the corporation in the active conduct of one or more qualified trades or businesses. The term qualified trade or business means any trade of business other than the following 18 : performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees; any banking, insurance, financing, leasing, investing or similar business; any farming business; any business involving the production or extraction of products of a character with respect to which a deduction is allowable under Code Secs. 613 or 613A; and any business of operating a hotel, motel restaurant or similar business. In addition, the active business requirement is deemed to have been met if, in connection with any future trade or business, a corporation is engaged in start-up activities, payment or incurring expenditures which may be treated as research and experimental expenditures, and activities which are regarded as inhouse research expenses. 19 Lastly, a special rule exists for entities that qualify as a specialized small business investment company. This rule waives the active business requirement for such companies; however, such companies must be an eligible corporation that CCH. All Rights Reserved.

5 May June 2011 is licensed to operate under Act Sec. 301(d) of the Small Business Investment Act of Original Issuance Requirement QSBS must be acquired by the taxpayer at its original issue, either directly or through an underwriter, for cash or property or as compensation for services provided to the corporation. 20 QSBS acquired by a taxpayer from a gift, inheritance or from a partnership distribution of property is treated as being acquired in the same manner and as having the same holding period of the transferor. 21 Redemption Provisions Although the previously mentioned original issuance requirement appears to be relatively straightforward, Congress added the redemption provisions to prevent evasion, as they believed a crafty tax practitioner could circumvent the purpose of the original issuance requirement by using certain redemption transactions not deemed to be de minimis. QSBS will lose its qualifying status if the qualifying small business were to purchase any of its own stock either directly or indirectly from persons who hold the stock or persons related to the holder of such stock within the fouryear period beginning two years before the issuance of such stock. The term related has the meaning set forth in Code Secs. 267(b) or 707(b). Further, stock issued by the qualifying small business shall not be treated as QSBS if the qualifying small business enters into a transaction deemed to be a significant redemption transaction. A significant redemption transaction is such that at any time during the two-year period, beginning one year before the issuance of such stock, the qualifying small business made one or more purchases of its own stock with an aggregate value, as of the time of the respective purchases, exceeding five percent of the aggregate value of all of its stock as of the beginning of the two-year period. 22 In addition to significant redemption transactions, transactions deemed to be certain constructive transactions under Code Sec. 304 also will disqualify the QSBS. The regulations under Code Sec provide for some de mimimis exceptions to certain transactions QSBS [is] any stock in a C corporation, which as of the date of issue is stock of a C corporation that is a qualified small business, acquired by the taxpayer at its original issue. that would otherwise disqualify the QSBS. First, redemptions of stock held by persons or related persons during the four-year period are disregarded if all such redemptions in the aggregate are either (a) less than $10,000 or (b) less than two percent of all QSBS held by such persons and related persons. To determine whether the two-percent limit is exceeded in applying the de minimis tests, the percentage of stock acquired in any single purchase is determined by dividing the stock s value by the value of all stock held directly or indirectly at the time of purchase by such persons or related persons immediately before the purchase. The percentage of stock acquired in multiple purchases is the sum of the percentages determined for each separate purchase. 23 Secondly, redemption transactions that are deemed significant will be disregarded if either the aggregate amount paid for the redeemed stock during the twoyear measuring period is (a) less than $10,000 or (b) less than two percent of all outstanding stock of the issuing corporation. To determine whether the two-percent limit is exceeded in applying the de minimis tests, the percentage of stock acquired in any single purchase is determined by dividing the stock s value (as of the time of purchase) by the value (as of the time of purchase) of all stock outstanding immediately before the purchase. The percentage of stock acquired in multiple purchases is the sum of the percentages for each separate purchase. 24 Certain redemptions that are incident to the events affecting a shareholder are deemed to be disregarded for purposes of determining whether the redemption exceeds the de minimis amounts. In particular, redemptions upon the termination of a shareholder s employment or the death, divorce, disability or mental incompetency of a shareholder are disregarded. 25 In addition, the transfer of stock by a shareholder to an employee or independent contractor or to the beneficiary of an employee or independent contractor is not treated as purchase of stock by the issuing corporation for purposes of the redemption provisions. 26 Example 5. On May 31, 2004, C Corporation purchased 100 shares of its common stock from T, an individual taxpayer. On April 1, 2006, C JOURNAL OF PASSTHROUGH ENTITIES 31

6 Private Equity and Hedge Fund Corner issues additional stock and T purchases some of this stock. Even if C Corporation meets the requirements of a qualified small business, the stock purchased by T on April 1, 2006, will not be qualified small business stock since C Corporation redeemed some of its stock from T within two years of issuance of the stock. Example 6. On June 30, 2005, C Corporation had 100,000 shares of common stock outstanding. T owned 4,000 shares of the stock, and S, U, and V each owned 32,000 shares of the stock. Each share of the stock was worth $10. On May 15, 2006, when the value of C Corporation stock had increased to $15 per share, C Corporation redeemed the 4,000 shares of stock that were owned by T by paying T $60,000 (4,000 shares times $15 per share). On June 30, 2006, C Corporation issued 40,000 additional shares stock, which were purchased by S, U, and V. None of the stock issued on June 30, 2006, will be qualified small business stock since C Corporation redeemed more than 5 percent of the value of its stock, based on the value of the stock as of June 30, 2005, within one year of June 30, 2006, the date of issuance of the stock. Options, Nonvested Stock and Convertible Instruments QSBS acquired by a taxpayer through the exercise of warrants or options, or through the conversion of convertible debt, is treated as acquired at original issue. The determination of whether the eligible corporation has satisfied the gross assets test is made at the time of exercise or conversion, and the holding period of such stock begins at that time. In other words, in the case of convertible debt, the holding period of the debt will not tack on when the debt is converted into stock. In the case of convertible preferred stock, the gross assets test is performed at the time the convertible stock is issued, and the holding period of the convertible stock is added to that of the common stock acquired upon conversion. Lastly, stock received in connection with the performance of services is treated as issued by the eligible corporation and acquired by the taxpayer when included in the taxpayer s gross income. 27 Special Provisions for Partnerships or Other Passthrough Entities While the federal tax savings of the 50-percent exclusion amount is somewhat negated by a 28-percent maximum capital gain rate and the AMT, there may be substantial state tax savings. The gain on the sale of QSBS held by a passthrough entity is excludable if the entity held the QSBS for more than five years, and if the partner, shareholder or participant of the passthrough entity to whom the gain passes through held an interest in the entity from the date the entity acquired the QSBS through the date of disposition of the stock. 28 In applying the per-issuer limitation, the participant of the passthrough entity is deemed to have a proportionate share of the adjusted basis of the passthrough entity s basis in the QSBS. In addition, the gain exclusion also may be limited to the extent the allocated gain exceeds the amount determined by reference to the interest held by the participant in the pass-through entity on the date the QSBS was acquired. 29 For purposes of the passthrough provisions, a passthrough entity is described as one of the following entities: a partnership, an S corporation, a regulated investment company and a common trust fund. In the examples below, we assume the passthrough entity is a partnership. Further, we illustrate the rules set forth in Code Sec. 1202(g) with the emphasis that the exclusion computation is performed at the partner level. It is the partnership s obligation to provide the necessary information via a footnote on the partner s Schedule K-1 in order to perform this computation. Example 7. P, a partnership, has three partners, T, J and A, each of whom own a one-third interest in the partnership. On September 30, 2001, P purchases from Corporation X for $1 million, 10,000 shares of QSBS. On October 30, 2006, P sells the stock for $10 million, realizing a $9 million gain. T, J and A each realize their allocable share of the gain of $3 million, and assuming the CCH. All Rights Reserved.

7 May June 2011 stock has met all QSBS eligibility requirements, T, J and A should be eligible for 50-percent gain exclusion as each of the partners held their interest in the partnership on the date it acquired the stock of X and at all times thereafter until the disposition of the stock. Example 8. Assume the same facts as in Example 7, except T sells T s interest in P to A on December 15, Of the $9 million gain that P realizes on the sale of X stock in 2006, $6 million of gain will be allocated to A, since A has a two-thirds interest in P as a result of A s purchase of T s interest in P. The remaining $3 million of the gain realized by P will be allocated to J. Similar to Example 7, J will be able to exclude 50 percent of the $3 million of gain allocated to him; however, A will not be able to exclude 50 percent of the $6 million passed through because A did not own a two-thirds interest in P at the time P acquired the X stock. The 50-percent exclusion for A will be limited to $3 million, which is the amount determined by reference to the one-third interest he held in P on the date P acquired the QSBS. Example 9. Assume same facts as in Example 7, except T had also purchased 10,000 shares of X Corporation stock for $1 million on September 30, 2001, and sold the stock on December 31, 2006, for $12 million. T realizes a gain of $11 million on the sale. T s total gain on the sale of QSBS is $14 million ($3 million of gain passed through from P plus the $11 million gain on the QSBS T held directly). T has a limit on the amount of gain from the sale of X stock that can be used for purposes of the 50-percent exclusion. The limit is the greater of 10 times T s basis in the X stock or $10 million. T s basis in X stock is computed as follows: 10 times the $1 million T paid for X stock directly held by T or $10 million, plus 10 times T s proportionate share of P s basis in X stock or $3,333,333 (10 times $333,333) for a total basis limitation of $13,333,333. Since $13,333,333 is greater than the alternative limitation of $10 million, $13,333,333 is the amount that can be used for purposes of computing the 50-percent exclusion amount. Consequently, $666,666 of T s $14 million realized gain cannot be used in computing the 50-percent exclusion. Example 10. Assume the same facts as in Example 7, except that T sells his one-third interest in P to A on December 31, 2001, and purchases the one-third interest back from A on October 1, No part of the gain on the X stock which is passed through to T can be used for purposes of the 50-percent exclusion since T did not hold his interest in P at all times from the date of acquisition of X stock until it was sold. Summary and Planning Opportunities Can Code Sec Be Utilized on the General Partner Carry? With respect to the general partner s share of the realized gain on the disposition of QSBS, we believe that the carried interest or preferred return catch-up received by the general partner should be eligible for the gain exclusion. The determination of a partner s proportionate share in a partnership that contains a complex allocation waterfall is unclear due to the lack of guidance; however, it is the authors belief that the profit allocation provisions or distribution waterfall provisions of the partnership agreement should dictate the general partner s proportionate share of gains realized by the fund. 30 Assuming no modifications to the allocation provisions contained in the partnership agreement, and assuming the general partner holds an interest in the partnership on the date the partnership acquires the QSBS and at all times through the date of disposition of the QSBS, the general partner should be entitled to receive the benefits of Code Sec based on its proportionate share dictated by the partnership agreement. Choice of Entity Considerations Fund managers should consider the type of entity used for future portfolio company deals, since structuring the entity as a C corporation might be the most tax-advantaged position, given the potential for 100-percent gain exclusion. Also, for funds that previously only invested in passthrough investments, perhaps an investment in the shares of qualifying C corporation stock is worth another look. This potential tax savings needs to be weighed against any premium the fund could realize on a portfolio company exit due to the benefit of an LLC basis step-up to the purchaser. JOURNAL OF PASSTHROUGH ENTITIES 33

8 As articulated in the opening of this column, planning opportunities exist for private equity funds. Even if the fund will not benefit from the favorable provisions recently added to Code Sec permitting 100-percent gain exclusion, we believe tax savings may exist under Code Sec that apply to qualifying portfolio company investments made pre-september 28, This Code Section is quite often overlooked, and fund managers and their investors could be missing out on substantial tax benefits. While the federal tax savings of the 50-percent exclusion amount is somewhat negated by a 28-percent maximum capital gain rate and the AMT, we strongly suggest that the proper analysis still be performed as there may be substantial state tax savings. 31 Further, if the fund s acquisition of QSBS falls within the 100-percent gain exclusion window, this will result in true 100-percent gain exclusion as the gain also will be exempt from AMT. 1 The authors would also like to thank Jonathan Norman and Adam Castic for their assistance in drafting this column. 2 Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (P.L ). 3 Omnibus Budget Reconciliation Act of 1993 (P.L ). 4 American Recovery and Reinvestment Act of 2009 (P.L ). 5 Small Business Jobs Act of 2010 (P.L ). 6 Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (P.L ). 7 Code Sec. 1202(a)(1). 8 Code Sec. 1(h)(3), (4), (7). 9 Code Sec. 1202(b)(1). 10 Code Sec. 1202(b)(1)(A). 11 Code Sec. 1202(b)(3). ENDNOTES 12 Code Sec. 1202(c)(1)(A) and (B). 13 Code Sec. 1202(e)(4). 14 Code Sec. 1202(d)(1). 15 Code Sec. 1202(d)(2). 16 Code Sec.1202(d)(3)(B), the term parentsubsidiary controlled group means any controlled group as defined in Code Sec. 1563(a)(1) except that more than 50% shall be substituted for at least 80% each place it appears in Code Sec. 1563(a)(1), and Code Sec. 1563(a)(4) shall not apply. 17 Code Sec. 1202(d)(3)(A). 18 Code Sec. 1202(e)(3). 19 Code Sec. 1202(e)(2). 20 Code Sec. 1202(c)(1)(B). 21 Code Sec. 1202(h)(1). 22 Code Sec. 1202(c)(3)(B). 23 Reg (a)(2). 24 Reg (b)(2). 25 Reg (d). 26 Reg (c). 27 Small Business Stock Explanation, Partial Gain Exclusion of Gain Under Section 1202, Tax Practice Series (BNA). 28 Code Sec. 1202(g). 29 Code Sec. 1202(g)(3). 30 Contrast this with Reg (d)(2), which limits gain exclusion to the smallest percentage interest in partnership capital; however, even in this section, the partner s percentage interest in partnership capital is not specifically defined. 31 The 50-percent exclusion currently produces an effective rate of 14 percent for regular tax and percent for alternative minimum tax purposes. The 75-percent exclusion currently produces an effective rate of 7 percent for regular tax purposes. This article is reprinted with the publisher s permission from the JOURNAL OF PASSTHROUGH ENTITIES, a bi-monthly journal published by CCH, a Wolters Kluwer business. Copying or distribution without the pub lish er s permission is pro hib it ed. To subscribe to the JOURNAL OF PASSTHROUGH ENTITIES or other CCH Journals please call or visit All views ex pressed in the articles and col umns are those of the author and not necessarily those of CCH or any other person. All Rights Reserved CCH. All Rights Reserved.