TAX NEWS - JUNE 2010

U.S. Tax: Change in Carried Interest Tax Passes House

by Paula Schaap, 01 June 2010 -- Private equity and hedge fund firms were dealt a major blow as the House passed legislation that would change the way so-called "carried interest" is taxed.

The provision, which was part of a larger bill that extended unemployment benefits and included other economic stimulus measures, passed 215 to 204 Friday.

The change would mean that 75% of carried interest, or the amount a private investment manager earns from the firm's performance, would be taxed at ordinary income rates, which can be as much as 35%, instead of the capital gains rate of 15%. The remaining 25% would be taxed as capital gains.

The latest proposal was a compromise between legislators who wanted the entirety of carried interest taxed as regular income and the private investment industry which fought against the tax law change for over three years.

The industry, especially lobbyists for private equity, argued that private investment managers who have to wait over time for their investment to pay off should be treated no differently than other types of business' investment in their product or services.

Proponents of the change countered that investment managers were usually making their profits off of other people's money, rather than their own investment in the business.

Although several versions of the current bill made it through the House in the past, it was allowed to sink out of sight in the Senate.

But this year, facing mounting deficits, the Senate is more likely to look favorably on a tax change that is expected to bring in $17 billion in tax revenues over the next 10 years, according to the Joint Committee on Taxation.