For years, Democrats and even some Republicans, such as former President Donald J. Trump, have argued that wealthy hedge fund managers and private equity executives have lower tax rates than entry-level employees. They have asked us to close the so-called carry-interest loophole that allows us to pay.
These efforts have always failed to create a major dent in the loophole — and the latest proposal to do so failed this week. Secure legislative votes, cut inflation legislation, broad climate, health care, and tax bills.
The agreement reached last week between Majority Senator Chuck Schumer and Democratic Senator Joe Manchin III of West Virginia was a small step toward narrowing the treatment of the effective interest tax. But that wouldn’t have completely eliminated the loophole, and it might have allowed wealthy managers to pay less taxes than secretaries.
Given the Democratic majority in the Senate, the fate of the clause has always been in doubt. And while Cinema had previously opposed the Carry Interests bill in a much larger bill called Build Back Better, it failed to secure the necessary 50 Democratic votes.
If the bill passed in the way Schumer and Manchin presented it last week, it would reduce the accrued interest exception and move Democrats a little closer to realizing their vision of a more progressive tax law. right.
What is Carrie Interest?
Carried Interest is the percentage of investment income that a private equity partner or hedge fund manager receives as compensation. In most private equity firms and hedge funds, the percentage of profits paid to the manager is around 20%.
Under existing law, that money is taxed on top earners at a 20% capital gains tax rate. This is about half of the higher personal income tax rate of 37%.
A 2017 tax law passed by Republicans left the treatment of carry interest largely intact after intense business lobbying, but gave private equity participants preferential treatment for carry interest after holding an investment for at least three years. Narrowed the exemptions by requiring them to enjoy the tax system. interest income.
What did the Manchin-Schumer Pact do?
An agreement between Mr. Manchin and Mr. Schumer would have further narrowed the exemptions in some respects. The holding period he extends from three to five years, while changing how the period is calculated, in hopes of reducing the ability of taxpayers to manipulate the system and pay his 20% lower tax rate. .
Senate Democrats said the change would force them to tax more income at a higher personal income tax rate and lower the tax rate at a preferential rate, meaning the change would raise an estimated $14 billion over 10 years. said that it would have been
The longer holding period only applies to those earning $400,000 or more annually, in line with President Biden’s pledge to not raise taxes on those earning less.
The tax provision mirrors similar measures that were first included in the sprawling climate and tax bill passed by House Democrats last year but ultimately stalled in the Senate. Carey’s wording of his interest was removed amid concerns that Mr. Cinema, who opposed the bill, would block the bill altogether.
Why was the loophole not closed until now?
For years, many Democrats have tried to completely eliminate the tax benefits private equity partners enjoy. Democrats have sought to redefine administrative expenses earned from partnerships as “gross income,” like other types of income, and treat capital gains from partners’ investments as recurring income.
included such movements Bill Proposed by House Democrats in 2015The law would also have increased penalties for investors who did not properly apply the proposed changes to their tax returns.
The private equity industry has hit back hard, outright rejecting the underlying concepts on which the proposed changes were based.
In a 2016 New York Times opinion piece, Steven B. Klinsky, founder and CEO of private equity firm New Mountain Capital, said, “There is no such loophole. ‘ said. Taking into account what was imposed by the New York City and state governments, his effective tax rate was 40-50%.
What does this change mean for private equity?
The private equity industry defends the tax treatment of carry interest, arguing that it creates incentives for entrepreneurship, sound risk-taking, and investment.
The American Investment Council, a lobby group for the private equity industry, described the proposal as a blow to small businesses.
“Last year, more than 74% of private equity investments went to small businesses,” said AIC CEO Drew Maloney. Private capital that helps local employers survive and grow. ”
The Managed Funds Association said the changes to tax law would hit people investing on behalf of pension funds and college endowments.
“Current law recognizes the importance of long-term investment, but the proposal would punish entrepreneurs in investment partnerships by denying them the benefits of long-term capital gains treatment,” said Brian Corbett, CEO of the association. Let’s go,” he said.
“It is critical that Congress avoid proposals that undermine the ability of pensions, foundations and endowments to profit from high-value, long-term investments that create opportunities for millions of Americans.”
Jim Tankersley contributed to the report.
