Carried Interest Tax Bill Introduced In US Congress

by Mike Godfrey, Tax-News.com, Washington

08 April 2009

Democratic lawmaker Sander Levin has reintroduced legislation into the US House of Representatives that would tax fund managers' carried interest compensation at the same rates as ordinary income.

Currently, the managers of private investment partnerships are able to receive compensation for their services at the long-term capital gains tax rate of 15% rather than the ordinary income tax rate, by virtue of their fund’s partnership structure. Levin's legislation, which is a repeat of a bill he introduced in 2007, clarifies that any income received from a partnership, capital or otherwise, in compensation for services is ordinary income for tax purposes. However, the capital gains rate will continue to apply to the extent that the managers’ income represents a "reasonable" return on capital they have actually invested themselves in the partnership.

“This is a basic issue of fairness,” said Levin. “Fund managers are receiving compensation for managing their investors’ money. They should not pay the 15% capital gains rate on their compensation when millions of other hard-working Americans, many of whose income is performance-based, pay ordinary rates of up to 35%."

Such a move is supported by President Obama who has inserted a similar proposal into his 2010 budget.

"The budget proposes to tax the compensation paid to hedge fund managers, private equity partners and others in the same way that we tax the wages paid to ordinary American workers," Treasury Secretary Tim Geithner told the House Ways and Means Committee in March. "By closing this carried interest provision, the tax code will provide equal tax treatment for wages regardless of whether an individual works as a teacher or a hedge fund manager."

Naturally, the venture capital and private equity industry is hostile to the idea, and in a position paper published last November, the Ohio Venture Association argued that erasing the tax advantage of carried interest would undermine support for entrepreneurship, particularly in states like Ohio with fragile economies.

"Venture capital, particularly early stage venture capital, is just beginning to penetrate traditionally late adopting markets across the Midwest. Early stage venture capital is generally managed locally by smaller, risk-taking venture capital firms that expect to manage investments in companies for five to nine years," the Association observed. "A large part of their compensation is carried interest, which is the share the firms earn in the equity gain of the businesses in which they invest."

"The presence of locally managed early stage venture capital is critical to supporting the transition of mature economies into entrepreneurial economics. An increase in tax rates borne by venture capital will slow or arrest the significant progress that has been made," the Association warned.

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