Staff of the House Ways & Means Committee, Joint Committee on Taxation, and Senate Finance Committee are holding a closed-door meeting today on the taxation of private equity fund managers. Among the academics and practitioner invited to attend is Victor Fleischer (Illinois), author of Two and Twenty: Taxing Partnership Profits in Private Equity Funds, 83 NYU L. Rev. ___ (2008).
Today’s Wall Street Journal editorializes against raising the tax rate on carried interest from 15% to 35%: Assault on the Investor Class:
Can anyone be surprised that the Congressional tax committees have set their sights on the private equity market as a source for new tax revenues? This week Senators Max Baucus and Charles Grassley, the chairman and ranking minority member of the Finance Committee, will hold "informal meetings" to ponder a 133% tax hike on private equity firms. There’s no good rationale for this beyond the fact that Congress wants money and private equity funds have lots of it. …
[F]und managers also typically lay claim to a 20% slice of the fund’s future profits. That return is called "carried interest" and is taxed at the long-term capital gain rate of 15%. Congress is considering reclassifying that income as labor compensation and taxing it at the 35% income tax rate. That’s bad tax policy for a lot of reasons.
"Carried interest" is long-term, risk-based investment income derived from future profits. Those profits are anything but a sure thing. Private equity managers get nothing from their equity holding until investors get all of their money back plus a negotiated return — which is a lot different than an upfront fee or a guaranteed wage or salary that comes as a paycheck every two weeks. Far from being a clever tax dodge, carried interest plays a central role in the performance of private equity funds: It establishes an incentive structure which aligns the financial interests of the managers and investors
Overturning this tax doctrine would have negative effects on a wide spectrum of other investment funds which use "carried interest" incentive structures, including real estate and oil and gas partnerships, and venture capital firms. Doubling the tax rate on public equity will hurt them for sure, but the lower after-tax returns will undoubtedly mean fewer deals, which will do collateral damage to investors and entrepreneurs who depend on this capital for financial sustenance. Last year a record amount of private equity investment went into the coffers of family-owned businesses — not multibillion dollar firms.
For more, see:
- Conglomerate: Taxing Private Equity: Do the Right Thing
- The Deal Blogs: Taxing PE
- Reuters: US Senator Weighs Tax Treatment of Private Equity
Prior TaxProf Blog coverage:
