The US House of Representatives today voted to subject the carried interest to tax as ordinary income and employment taxes.
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In what could be a serious blow to the venture fund industry, the President’s tax proposals contemplate taxing carried interest as ordinary income, subject to ordinary income tax rates and self employment taxes.
The proposal states that it “is not intended to adversely impact qualification of a real estate investment trust owning a carried interest in a real estate partnership.”
Excerpt from a summary of the President’s proposal is below. You can also find them on pages 25 and 26 of this document.
Rep. Levin Re-Introduces Legislation To Tax Venture Capital Fund Carried Interest As Ordinary Income
As if the venture capital industry did not have enough to worry about, with the Treasury’s proposal to require venture funds above a certain size (not yet specified) to register with the SEC, it also appears that the effort to tax their “carried interest” as ordinary income will remain in the mix. Representative Sander Levin, of Michigan, re-introduced legislation last Friday that would tax the carried interest of venture capital funds as ordinary income.
Excerpts from his press release (which can be found on the House Ways and Means Committee web site) are below:
“Washington, DC – Rep. Sander Levin today reintroduced legislation to tax carried interest compensation at the same ordinary income tax rates paid by other Americans. Currently, the managers of private investment partnerships are able to receive compensation for these services at the much lower capital gains tax rate rather that the ordinary income tax rate by virtue of their fund’s partnership structure.
“This is a basic issue of fairness,” said Rep. 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%. The President’s budget recognizes that this is unfair. The House of Representatives has recognized that it is unfair, and this year I hope we can act to change the law.”
The legislation clarifies that any income received from a partnership, capital or otherwise, in compensation for services provided by the employee is subject to ordinary tax rates. As a result, the managers of investment partnerships who receive a carried interest as compensation will pay regular income tax rates rather than capital gains rates on that compensation. 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 proposal is not about taxing investment, it’s about ensuring that all compensation is treated equally for tax purposes. Anyone who actually invests money in these funds will continue to receive capital gains treatment, including the managers. So there is no reason to expect that the amount of capital available for these kinds of investments will be reduced,” concluded Levin.
Levin introduced similar legislation in the 110th Congress, which was subsequently included in several tax packages approved by the Ways & Means Committee and the House of Representatives. A similar proposal is also included in President Obama’s FY 2010 budget request.
Click here to view the legislation.”
“Myth: This change to the taxation of carried interest will harm every “mom and pop” partnership in America.
Fact: The change would only affect those partnerships where service income is being improperly converted to capital gains.
This legislation would have no effect whatsoever on the vast majority of partnerships that are engaged in ongoing businesses and whose profits are already being properly taxed an ordinary income tax rates. It does apply to investment fund partnerships where the investors in the fund choose to compensate the people managing their assets through a carried interest. In practice, this means hedge funds, private equity funds, venture capital funds and real estate partnerships. The reality is that the fund managers and general partners who would be asked to pay ordinary income tax rates on their compensation are a very small, very well-paid group of professionals. It is also important to note that the bill does not discriminate among partnerships based on the kind of assets they purchase.”