President Obama has proposed increasing the tax rate on carried interest from the long term capital gains tax rate to the ordinary income tax rate, and his proposed budget includes the benefits of this tax increase. According to officials within the administration, this contemplated tax increase would apply not only to hedge funds, but also to private equity and venture capital funds. See here.
We will keep you posted as we learn more.
From the New York Times: "some people think that a carried-interest tax increase could be put back on the table." See also this article in PEHUB.
What I haven't seen written about in the various tax articles that have been written recently is how state and local tax increases will affect contemplated federal tax hikes. Both California and New York City are considering income tax hikes. Since state and local income taxes are deductible for federal income tax purposes, if state and local governments across the country raise income taxes this could reduce the federal revenues expected to be derived from federal income tax hikes, which might necessitate higher federal income tax hikes than previously contemplated.
It would appear that everyone is expecting that this tax "break" or "loophole" will be closed.
There were a number of articles to this effect written today, including one in CNNMoney, and another at GlobeSt.com.
It will be crucial to the venture capital industry and the real estate industry that any modification to the tax law to take away the carried interest tax "break" for larger institutions (where there is perceived executive compensation excesses) does not inadvertently or intentionally capture venture capital and real estate partnerships as well.
We will keep you posted.
The Institute for Policy Studies and United for a Fair Economy have issued a report titled Executive Excess 2008: How Average Taxpayers Subsidize Runaway Pay which puts the cost of the "carried interest" tax break at $2.6 billion annually.
With the populist economic agendas of Obama and Biden at the forefront of our national debate, there is almost certain to be more legislative action on this front. We will keep you posted.
On Friday, the National Venture Capital Association issued a press release expressing "regret" that the U.S. House of Representatives approved legislation to increase the tax on carried interests to ordinary income tax rates. It is unclear how the House legislation will be received in the Senate.
On November 1, 2007, the U.S. House Ways & Means Committee passed the Temporary Tax Relief Act of 2007. A summary of the legislation can be viewed here. The bill includes, in addition to individual alternative minimum tax relief, tax increases--including taxing carried interest income received by investment fund managers in investment funds as ordinary income. As summarized in the Ways & Means press release:
H.R. 3996 contains provisions to change the tax treatment of "carried interest" for investment fund managers. Under the Committee-passed legislation, they will no longer receive a lower capital gains rate of 15% for what is essentially a management fee or payment for services. Partners and managers would continue to receive a lower rate of taxation on returns derived from money they have personally invested.
In addition to other things, the bill would also allow certain tax-exempt entities to invest directly in investment partnerships without incurring unrelated business income tax, which would eliminate the current-law incentive for such entities to invest in investment partnerships through “blocker” corporations.
The National Venture Capital Association had this reaction.
Committees in both the Senate and the House held hearings on the carried interest yesterday. In advance of these hearings, the Joint Committee on Taxation issued two publications: Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues, Part I (JCX-62-07); and Present Law And Analysis Relating To Tax Treatment Of Partnership Carried Interests And Related Issues, Part II (JCX-63-07).
You can also find other materials on the hearings at http://taxprof.typepad.com/taxprof_blog/2007/09/more-on-yesterd.html.
The New York Sun reported on Friday, August 17, that Rep. Charles Rangel believes his plan to combine AMT reform with an increase in the carried interest tax may be veto proof. President Bush opposes the tax. We have previously blogged on Rep. Rangel's idea of combining the two measures. In the Senate, Senator Charles Schumer has said he plans on introducing a bill that would increase the tax on carried interest in all partnerships, not just investment partnerships. The bill co-sponsored by Rep. Rangel would create a new Internal Revenue Code Section 710, which would specifiy that any income with respect to an "investment services partnership interest" would be treated as ordinary income for the performance of services, not capital gain.
An "investment services partnership interest" as defined in Rep. Rangel's co-sponsored legislation is an interest in a partnership held by a person if such person provides, directly or indirectly, in the active conduct of a trade or business, a substantial quantity of any of the following services to the partnership:
"Specified assets" include, generally, securities, real estate, commodities, or options or derivatives contracts with respect to securities, real estate, or commodities. There is a carve out for capital interests, but only if allocations with respect thereto are reasonable. In other words, under the proposed legislation, partners who hold an "investment services partnership interest" and a capital interest cannot escape the ordinary income tax treatment on their income related to investment management services through an unreasonable allocation with respect to their capital interest.
Bloomberg reported on August 3, 2007, that House Ways and Means Committee Chairman Charles Rangel said in an interview that he will combine the proposed carried interest tax increase with AMT reform in the fall. Combining these measures may increase the likelihood of passage of an increase on the tax on carried interest. Rangel is a co-sponsor of legislation to increase the tax on carried interest.
View text of the proposed legislation; here is the carried interest in pdf form.
View text of press release accompanying proposed legislation.
View fact sheet distributed with press release announcing proposed legislation.
For further information, please contact Joe Wallin, 206.757.8184, or joewallin@dwt.com.
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