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Wyden Bill Would Close US Carried Interest 'Loophole'

by Mike Godfrey,, Washington

31 May 2019

On May 23, 2019, the Ranking Member of the United States Senate Finance Committee, Ron Wyden (D-OR), introduced a bill to change the tax treatment of income earned by investment fund managers.

An overview of the proposals notes that carried interest is a form of compensation received by a fund manager in exchange for investment management services, which entitles a fund manager to future profits of a partnership, also known as a "profits interest."

Under current law, a fund manager is generally not taxed when a profits interest is issued and only pays tax when income is realized by the partnership, often in connection with the sale of an investment some time later. In addition, the eventual income from the partnership usually takes the form of capital gains income, which is taxed at 23.8 percent compared to the top rate of 40.8 percent for wage-like income.

According to Wyden, the Ending the Carried Interest Loophole Act "closes the entire carried interest loophole" by requiring fund managers to recognize deemed compensation income each year and to pay annual tax on that amount, preventing them from deferring payment of taxes on wage-like income. Furthermore, under the bill, a fund manager's compensation income would be taxed similar to wages and subject to ordinary income rates and self-employment taxes.

The bill calculates a fund manager's deemed compensation amount by applying a standard rate of return to the portion of the investors' capital used to invest for the manager's own account with the deemed compensation amount being the estimated forgone interest. Under these changes, the fund manager realizes a long-term capital loss equivalent to the deemed compensation amount, preventing the transformation of compensation income into lower-taxed capital gains.

TAGS: Finance | tax | investment | interest | law | self-employment | United States | services

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