Private-Equity Managers Could Take Tax Hit Under New Legislation

Three times in as many years the House has sought to eliminate a lucrative Wall Street tax break by passing legislation that would increase taxes on "carried interest"--the standard form of compensation for partners of private-equity firms. And each time the Senate, under intense lobbying pressure from private-equity firms, venture capital firms and hedge funds, has killed the legislation.

A carried interest bill--this time called--HR 4213, the American Jobs and Closing Tax Loopholes Act--is once again back before the Senate having been passed by the House in late May. However, this time the fate of the measure could be very different given the great anger of the public toward Wall Street.

Backers of the legislation say that by treating the profits from carried interest as ordinary taxable income the federal budget deficit could be reduced by more than $18 billion dollars over the next ten years.

Private-equity firms currently pay taxes on carried interest at the long term capital gains rate of around 15 percent. The new rules proposed by the House would treat those earnings as ordinary income with a tax rate of around 39 percent. Supporters of the tax rate change for carried interest say that it is unfair that only a small select group of people---mainly partners of private-equity firms and hedge funds--benefit from the current tax rules.

Understanding their lack of popularity, lobbyists for private-equity firms and hedge funds have decided to concentrate on scaling back the measure realizing that killing it outright is most likely not in the cards. 

To win concessions from Senators, lobbyists are claiming that any dramatic increase in taxes on carried interest could have a chilling impact on venture capital and discourage the kind of investment needed to encourage innovation in areas like clean energy that are key to growing the jobs of the future.

According to the Washington Post, private-equity lobbyists have enjoyed some success. The Senate has agreed the tax increase wouldn't go into effect until 2011--"when half of the carried interest would be taxed as ordinary income" with the rest still being treated as long term capital gains. After 2013, 75 percent would be treated as ordinary income.

The Senate will continue debating the legislation with a the goal of getting a final bill to the President before July 4.