December 14, 2009 blog
http://www.greencompany.com/blog/index.php
Carried-interest tax hike back in the news
The House passes carried-interest repeal; the bill's fate in the Senate remains to be seen.
Last week, the House passed a bill to repeal carried interest tax breaks for investment managers effective in 2010 â HR 4213, the "Tax Extenders Act of 2009â
http://www.govtrack.us/congress/vote.xpd?vote=h2009-943 â to extend many tax breaks, and partially pay for those breaks with tax revenue generated from this possible increase. This bill accelerates the already scheduled repeal effective in 2011, per the Obama 2010 budget passed in early 2009 (Click here for more.)
Weâve been warning managers of the repeal of carried interest tax breaks for more than two years. We told our clients to expect it to happen sooner rather than later based on the mood in Congress. The writing was on the wall during the 2008 presidential campaign and in Congress (in prior bill language that did not pass). Despite useless and unwise efforts by the hedge-fund industry to lavishly send Democrats higher campaign contributions, the likelihood of this repeal advanced with growing populist anger in America (and in both parties of Congress) against Wall Street over TARP bailouts, the meltdown, Wall Street recovering much faster than Main Street, high banker bonuses, and stricter lending requirements (with insufficient lending to Main Street).
Now in connection with jobs bills being considered, Congress is promising tax cuts to small business job creators and hopes to pay for these tax cuts with tax increases on Wall Street and the upper class. Tax threats against Wall Street and the trading community include bonus one-off taxes (similar to those just passed in the UK and France), a global financial-transaction tax (Tobin Tax), and unfortunately repeal of carried-interest tax breaks for investment managers. There are tax increases scheduled for the upper income in 2011 when the Bush Administration tax cuts expire. Will Congress jump the gun on some of these tax increases next?
Weâve been focusing our recent efforts to defeat a financial-transaction tax at home and abroad. The carried-interest tax breaks were already repealed for 2011, but Congress has jumped the gun, tagging a one-year acceleration repeal onto a tax-break extension bill. Itâs hard to vote no or campaign against that. That fight was mostly lost a year ago.
Hopefully, the Senate will not agree with the House bill and give investment managers another year to deal with this significant tax increase. At least itâs not retroactive to 2009. Some states are passing retroactive tax increases now and that is especially nasty.
Repeal of carried-interest tax breaks for investment managers will significantly raise the income tax bills of profitable investment managers. But it should not put them out of business like the financial-transaction tax will surely do for hyperactive traders. Note that the carried-interest tax breaks still apply to investors in a fund, who can reduce capital gains income (with the managers profit allocation) rather than be stuck with restricted investment expense treatment.
With this repeal, a hedge fund will have the same tax treatment as managed accounts, with full earned ordinary income subject to ordinary tax rates and self-employment taxes. The only way an investment manager can avoid ordinary income and receive a lower long-term capital gains benefit is to personally invest money in his own hedge fund. Even the managerâs investment is deemed ordinary earned income. The recent version of the bill includes real estate rental and investment funds but exempts real estate development and oil and gas funds.
Some managers may now prefer to use managed accounts to save on fund legal, accounting, tax, audit, and compliance costs. Others may prefer to keep the fund structure in order to provide profit allocation tax breaks to investors, and for the overall convenience, less transparency, and combined account savings of a fund. Financial reform may throw other kinks into these trade offs as well.
Prior blogs on carried interest tax breaks being repealed:
Trader tax & carried interest updates (April 28, 2009)
Carried Interest Update (Aug. 1, 2007)
Carried Interest in Jeopardy (June 27, 2007)
