On July 4, 2025, President Donald Trump signed H.R. 1 into law, the budget reconciliation bill known as the One Big Beautiful Bill Act (the Act). As discussed in our prior alert following the passage by the House of Representatives of the original One Big Beautiful Bill (the Initial House Bill), this legislation includes amendments to the Internal Revenue Code (the Code) that could have significant consequences for investment funds and sponsors. This alert summarizes certain key tax provisions of the Act that could impact investment funds and sponsors, noting where relevant the differences between the Initial House Bill and the Act, as finalized.
This summary begins with what the Act does not do, which may in many regards be as important as what it does, and then provides a summary of the changes made by the Act.
What the Act Does Not Do:
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No Retaliatory Tax on Certain Foreign Investors. The Initial House Bill added new Code Section 899, which would have imputed a retaliatory tax (from 5% to as high as 20%) on certain types of income of certain non-U.S. persons that are residents of or otherwise have sufficient nexus with "discriminatory foreign countries" that have "unfair foreign taxes." Bringing good news for investment funds with foreign investors, Code Section 899 was removed from the Act prior to its enactment.
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No Increased Tax on Net Investment Income of Private Foundations. Private foundations that are exempt from tax are subject to a 1.39% excise tax on their net investment income. While the Initial House Bill would have introduced a new tiered system with significantly higher tax rates, the increased taxes contemplated by the Initial House Bill are not included in the Act.
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No Carried Interest Provision. Despite suggestions in the months leading up to the passage of the Initial House Bill and the enactment of the Act that such legislation could include provisions treating carried interests as ordinary income subject to employment taxes, the Act, like the Initial House Bill before it, does not contain any provision implementing such treatment. This leaves the current treatment of carried interests in place, at least for now. This is good news for sponsors of U.S. private equity funds that benefit from the generally favorable tax treatment of income received pursuant to a carried interest.
What the Act Does:
- Permanently Extends Section 199A 20% Deduction and Other Tax Rates. The Act permanently extends the Section 199A deduction, which was enacted by the Tax Cuts and Jobs Act of 2017 (TCJA) to provide a tax rate reduction to noncorporate owners of pass-through entities, thereby serving as somewhat of a parallel reduction to the corporate tax rate enacted by the TCJA. Under the TCJA, the Section 199A 20% deduction applied through 2025 only. The Act also makes permanent the top marginal income tax rate of 37%, which otherwise would have reverted to 39.6% in 2026.
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The Section 199A deduction is generally based on a noncorporate taxpayer's allocable share of "qualified business income." The noncorporate owner may deduct 20% of their (i) qualified trade or business income from pass-through entities plus (ii) the aggregate amount of qualified REIT dividends (generally any REIT dividend that is not a capital gain dividend or qualified dividend income, and subject to certain holding period requirements). The Act also makes permanent the top individual tax rate of 37%. This means that the 20% deduction results in a federal effective tax rate of as low as 29.6%. We expect the permanent extension the deduction to be a significant benefit to certain investment funds — for example, those that own interests in REITs, or certain funds with income from a trade or business.
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The Act omits the extension, included in the Initial House Bill, of the Section 199A deduction to interest and dividends of qualified business development companies. The Act also does not include the increase in the deduction percentage from 20% to 23% that the Initial House Bill included.
- Expands Income Exclusion for Qualified Small Business Stock (QSBS). The Act makes Section 1202 an even more significant tax advantage for certain private equity funds than it currently is. Under current law, noncorporate taxpayers may exclude from gross income gain from the sale or exchange of QSBS held by the taxpayer for more than five years — subject to certain caps and limits. The Act shortens applicable holding period requirements and increases the gain exclusion possibilities, thereby potentially resulting in higher after-tax returns for investors.
- The Act:
- Increases the cap on gain exclusion from $10 million to $15 million. The cap will now be indexed for inflation.
- The gain that can be excluded for the stock of an issuer will now be the greater of: (1) $15 million per shareholder (adjusted for inflation), or (2) 10 times the shareholder's adjusted basis in the QSBS of the issuer sold during the year by the shareholder (the latter part of the rule was not changed by the Act).
- The gross asset value cap for QSBS issuers is increased from $50 million to $75 million. This will now also be indexed for inflation.
- Finally, the five-year hold period required to exclude gain is shortened. While the exclusion for the shorter hold periods is not 100%, it still results in greater benefits than under current law:
- For stock sold after three years – 50% of the gain is excluded. The tax rate that applies to the nonexcluded gain is 28% (the long-term capital gains tax rate in effect when Section 1202 was enacted). The 3.8% net investment income tax also applies to the excluded gain, resulting in a federal effective tax rate of 15.9%.
- For stock sold after four years – 75% of the gain is excluded, resulting in a federal effective tax rate of 7.95%.
- For stock sold after five years – the exclusion continues to be 100%, resulting in an effective federal tax rate of 0%.
- Seven percent of the excluded gain is treated as an alternative minimum (AMT) preference item.
- These expanded rules generally apply to qualifying stock issued after July 4, 2025. The prior provisions of Section 1202 will generally continue to apply to qualifying stock issued on or prior to July 4, 2025.
- Permanently Repeals Most Miscellaneous Itemized Deduction Limits. The Act, like the Initial House Bill before it, permanently disallows miscellaneous itemized deductions for individuals. This change makes permanent the TCJA's suspension of such deductions, which was otherwise set to expire after 2025.
- Generally, an investor's allocable share of a general partner's management fee and similar investment expenses associated with an investor fund (as opposed to a fund that is considered to be engaged in a trade or business) are considered miscellaneous itemized deductions. As a result, individual investors in investor funds will generally no longer be able to deduct management fees or similar investment expenses allocated to them by the investor fund. This may result in greater tax planning to achieve an economic result similar to a deduction.
- Increases Excise Taxes on Investment Income of Private Colleges and Universities.
- The Act increases the 1.4% excise tax that is imposed on certain college and university endowments, though the rates under the Act are still significantly lower than those proposed by the Initial House Bill. The Act enacts a three-tiered tax rate, which is based upon the "student-adjusted endowment" per student of the university:
- While the scope of the excise tax been scaled back from that proposed by the Initial House Bill (which had a top rate of 21%), the increased tax under the Act for certain endowments is still quite significant. This change is effective for tax years beginning after December 31, 2025. The tax will apply only to institutions with at least 3,000 tuition-paying students in the prior year, regardless of their endowment size (up from the threshold under current law of 500).
- Relaxes Section 163(j) Limitation on Deductibility of Business Interest. Section 163(j), enacted by the TCJA, generally limits the deduction for business interest expense to 30% of a taxpayer's "adjusted taxable income." For tax years before 2022, "adjusted taxable income" was calculated similar to earnings before interest, taxes, depreciation, and amortization (EBITDA), but for tax years starting in 2022, was calculated similar to earnings before interest and taxes (EBIT). For taxable years beginning after December 31, 2024, the Act relaxes the limitation on deductibility by reverting to the limitation in effect for tax years before 2022 (e.g., 30% of EBITDA), making this permanent. However, for taxable years beginning after December 31, 2025, the Act also provides that certain capitalized interest will not be treated as business interest expense for purposes of calculating the business interest deduction, and provides a new ordering rule for calculating the deduction.
- We generally expect that the reversion to the pre-2022 rule for calculating the Section 163(j) limit will be favorable for many funds, and their leveraged blockers. However, funds, their leveraged blockers, or investments using significant leverage will have to calculate the specific net impact to them.
