House Democrat Tax Bill Targets Private Equity, Hedge Funds

by Leroy Baker, Tax-News.com, New York

26 June 2007

House Democrats have introduced legislation that would ensure that investment fund managers who take a share of fund profits as compensation for investment management services - known as "carried interest" - would be taxed at an appropriate ordinary income tax rate.

Currently, the managers of private investment partnerships are able to receive compensation for these services at the much lower 15% capital gains tax rate rather than the ordinary income tax rate, by virtue of their fund’s partnership structure.

"Congress must ensure that our tax code is fair. We have to be sure that the lower capital gains tax rate is not being inappropriately substituted for the tax rate on wages and earnings," explained Rep. Sander Levin (D - Mich.), who introduced the bill along with Charles Rangel, Rep. Barney Frank (D - Mass.) and ten other Democrat members of the Ways and Means Committee.

"Investment fund employees should not pay a lower rate of tax on their compensation for services than other Americans," continued Rep. Levin. "These investment managers are being paid to provide a service to their limited partners and fairness requires they be taxed at the rates applicable to service income just as any other American worker."

The legislation clarifies that any income received from a partnership, capital or otherwise, in compensation for services is ordinary income for tax purposes. As a result, the managers of investment partnerships who receive carried interest as compensation would pay regular income tax rates rather than capital gains rates on that compensation. The capital gains rate would continue to apply to the extent that the managers’ income represents a reasonable return on capital that they have actually invested in the partnership.

The Ways and Means Committee is scheduled to hold a hearing on the issue of tax fairness in July.

Senators Max Baucus (D-Mont.) and Chuck Grassley (R-Iowa), Chairman and Ranking Republican Member of the Senate Finance Committee, have introduced similar legislation in the Senate.

“The nature of investment vehicles is changing right before our eyes, and the tax code must keep up with the times,” Baucus explained in introducing the Senate bill. “Creative new structures for investment vehicles may blur the lines for the tax treatment of income. We must make the law clear and apply the law fairly, or risk the erosion of our corporate tax base. If a publicly traded partnership makes its money by providing financial services, that active business should be taxed as a corporation."

Recommended