What Would the New Carried Interest Loophole Proposal Do?

For years, even some Republicans, such as Democrats and former President Donald J. Trump, will allow wealthy hedge fund managers and private-equity executives to pay lower tax rates than entry-level employees. I’ve been asking you to close the loophole in the so-called carry interest.

This week, a consensus was reached between majority leader Chuck Schumer and West Virginia Democrat Joe Manchin, taking a small step towards narrowing its special tax system. rice field. However, it does not completely eliminate loopholes and may allow rich executives to pay less tax than their secretaries.

Given that the Democratic Party has a majority in the Senate, the fate of this provision was not yet clear. Republicans are united against tax increases, so they will need all 50 Democrats to support the bill. But if the bill is passed, the reduction of carry-over profit exceptions will bring Democrats a little closer to realizing their vision of making tax law more progressive.

What will be carried?

Interest carried forward is the percentage of the return on an investment that a private equity partner or hedge fund manager receives as compensation. In most private equity firms and hedge funds, the share of profit paid to managers is about 20 percent.

Under existing legislation, the money is taxed at a capital gains rate of 20 percent for the top earners. This is about half of the 37%, which is the upper layer of personal income tax.

The Republican-passed 2017 tax law left most of the carry-over interest treatment after a fierce business lobby campaign, but withheld investment in private equity officials for at least three years before applying tax incentives for carrying. Interest income narrowed tax exemption by demanding.

What does the Manchin-Schumer Agreement do?

The agreement between Manchin and Schumer will further narrow tax exemptions in several ways. In the hope of reducing the taxpayer’s ability to abuse the system and paying a lower 20% tax rate, we will extend its holding period from 3 years to 5 years, changing the method of calculating the period.

The Senate Democratic Party has stated that the change will raise an estimated $ 14 billion over a decade by raising the personal income tax rate and lowering the preferential tax rate to tax more income.

The longer holding period applies only to those who earn more than $ 400,000 a year, in line with President Biden’s pledge not to raise taxes on those who earn less than that amount.

The tax provisions, which were initially included in the vast climate and tax bill passed by Democrats last year, reflect similar measures that eventually stalled in the Senate. The words of interest carried over have been removed in fear that Arizona’s Democratic Senator Kyrsten Sinema, who opposed the bill, would interfere with the law as a whole. So far, Cinema hasn’t indicated whether he agrees with any of the tax provisions for the new package. Democrats were basically betting that relatively small changes to increase income would not block big bills.

Why haven’t the loopholes been closed so far?

Many Democrats have been working for years to completely eliminate the tax incentives that private equity partners enjoy. The Democratic Party has sought to redefine the management fees from partnerships as “gross income” like any other type of income, and treat capital gains from partner investments as recurring income.

Such a move was included in Law proposed by the Democratic Party of the House of Representatives in 2015.. The law would also have increased penalties for investors who did not properly apply the proposed changes to their own tax returns.

The private-equity industry has vehemently counterattacked, completely rejecting the basic concepts underlying the proposed changes.

“There is no such loophole,” wrote Stephen B. Klinsky, founder and chief executive officer of private-equity fund New Mountain Capital, in an opinion piece published in The New York Times in 2016. .. Considering what was collected by New York City and the state government, his effective tax rate was between 40 and 50 percent.

What does this change mean for private equity?

The private equity industry has defended the tax treatment of carry-forward profits, claiming to create entrepreneurship, sound risk-taking and investment incentives.

The American Investment Council, a lobbying group in the private equity industry, described the proposal as a blow to small businesses.

Drew Maloney, CEO of AIC, said: “Last year, more than 74% of private equity investment went to SMEs. Private capital helping local employers survive and grow.”

The Managed Funds Association said tax law amendments would hurt those who invest on behalf of pension and university funds.

“Current legislation recognizes the importance of long-term investment, but this proposal will punish investment partnership entrepreneurs by not giving them the benefits of treating long-term capital gains,” said the association’s chief executive officer. One Brian Corbett said.

“It is important for Congress to avoid proposals that undermine the capacity of pensions, foundations and endowments to benefit from high-value, long-term investments that create opportunities for millions of Americans.”

Jim Tankasley Contribution report.