By Jessica Holzer - 05/15/07 07:30 PM EDT
Senate Finance Committee staffers are looking into reclassifying the so-called “carried interest” that alternative-investment fund managers earn from capital income to ordinary income, effectively boosting their tax rates from 15 percent to as high as 35 percent.
“They’re concerned with highly compensated hedge fund and private equity managers. Our concern is that changes would affect not only those managers but the smallest of real estate deals,” said Steve Renna, counsel to the Real Estate Roundtable.
A spokeswoman for the National Venture Capital Association, Emily Mendell, said it would be “ironic” and “terribly, terribly unfortunate” if venture capital were swept in under the change because of the role it plays in the economy.
“We build young companies into significant economic contributors. It’s not something you want to discourage,” she said.
A Senate Finance Committee aide lumped the real estate and venture capital sectors in with hedge funds and private equity as alternative investments that could be targeted by the change.
“It is difficult to justify a 15 percent tax rate for the performance of services in one set of circumstances — private equity, venture capital, hedge funds, high-dollar real estate — while at the same time a John Deere or Mary Kay salesperson who gets a bonus for performing their job well will be taxed at a higher rate of often 33 percent to 35 percent,” the aide told The Hill yesterday.
In a limited partnership, the general manager typically takes a 20 percent cut of the profits from the investment, called the “carried interest” or the “carry,” in addition to a fixed fee that usually amounts to two percent of the funds invested.
In theory, the carry is taxed at the lower rate for capital income because, unlike a salary, it is not guaranteed and often isn’t paid in the year that the manager performs services to the partnership.
But critics argue that the treatment is a loophole that allows fund managers to escape taxation at the same ordinary income rates paid by other professionals.
The venture capital and real estate industries have been meeting with tax committee staffers in the House and Senate to persuade them that the changes could have sweeping ramifications for the taxation of partnerships.
In particular, the lobbyists emphasize the importance of encouraging industries vital to the economy. In 2005, companies that received venture capital some time in the last 35 years accounted for 10 million U.S. jobs and $2.1 trillion in revenues, Mendell said.
Senate Finance Committee Chairman Max Baucus (D-Mont.) insisted earlier this month that his committee was “nowhere close” to drafting legislation on the issue, tamping down some of the heated speculation about his committee’s probe.
“We’re in the fact-finding state and we’re looking at all the issues that cover this area of the tax code,” a Baucus aide said yesterday.
But the committee seems to be moving ahead on the issue. Last week, staffers met with tax experts and stakeholders for a roundtable discussion of any change to the tax treatment of carried interest.
Meanwhile, the quest for revenue due to the reinstatement of pay-go rule is also exacerbating the lobbyists’ concerns. “They’ve got to get the money somewhere under pay-go rules. Anything being discussed you have to take extremely seriously,” Renna said.