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U.S. Tax: Tax break for money managers hangs on amid financial debate

For three years in a row, many of the country's wealthiest financiers have held on to what critics call an enormous tax break for Wall Street. The story is the same every time: A measure that would change the tax treatment of "carried interest" passes the House, only to hit a wall in the Senate.

It's back, this time in the jobs bill approved by the House last month. And if ever there were a time to pass a tax increase on billionaire money managers -- between public anger at Wall Street and lawmakers grasping for revenue anywhere they can find it -- this would be it.

Yet the Senate looms. Two powerful Democrats -- Majority Leader Harry M. Reid (Nev.) and Finance Committee Chairman Max Baucus (Mont.) -- were working Monday to soften the tax provision, to satisfy the concerns of a few senators worried about its effect on venture capitalists. Aides said Senate leaders are optimistic that they can muster the 60 votes needed to pass the change, but it could lead to problems in the House.

The provision would haul in roughly $18 billion by raising taxes on the income of people who run private-equity firms, venture-capital shops and real estate investment partnerships. Carried interest is the cut these firms make off the appreciation of their clients' portfolios.

When the firms sell long-run investments, those profits are treated as long-term capital gains, which means they're taxed at no more than 15 percent. Critics say those earnings should be taxed as ordinary income, or as much as 39.6 percent, because the partners manage other people's money, not their own.

"This is not a tax benefit that's available to doctors or teachers or firefighters," said Victor Fleischer, an associate professor of law at the University of Colorado at Boulder. "It's a tax benefit that's only available to investment managers."

Industry lobbyists won some concessions in the House bill. First, the tax increase would not take effect until 2011, when half of the carried interest would be taxed as ordinary income, with the rest still as capital gains. After 2013, 75 percent would be treated as ordinary income.

Given the lack of sympathy for Wall Street, lobbyists are playing up how the measure would affect lower-profile members of their coalition: commercial real estate investors who form partnerships to invest in strip malls and office buildings. According to the industry trade group Real Estate Roundtable, there is $6.5 trillion worth of commercial real estate in the United States. Of that amount, real estate investment partnerships own $2 trillion.

"We are in a full-scale effort to make sure that senators understand this is a Main Street tax increase," said Jeffrey DeBoer, president and chief executive of the Real Estate Roundtable. DeBoer added that raising the tax could jeopardize the value of already-struggling commercial real estate developments.

The effect on venture capital has also raised worries in Silicon Valley and among some academics, who say the higher tax could discourage the kind of investing that led to companies such as Google and

"At a time when the nation is in desperate need of innovation in the life sciences and clean technology industries, how could we possibly consider penalizing those professionals who are committed to bringing these breakthroughs to market?" wrote a handful of science professors from Harvard, the Massachusetts Institute of Technology and other universities in a letter to President Obama in May.

Robert Johnson, founder of Black Entertainment Television and a private-equity investor, added his voice to the mix, arguing that the rule would lead to "a rapid decline" in minority-owned private-equity firms. As the measure comes up for debate in the Senate, lobbyists say they are focused less on killing the rule altogether and more on negotiating the percentage breakdown on the taxation. They're also asking senators to pay attention to a related measure that's mostly flown below the radar, which would make it more expensive for partners to sell their own firms. The bill would tax these sales as ordinary income, rather than capital gains.

Lobbyists say some senators have been surprised to learn about this other tax. "When you talk to . . . [senators] who have been in business they basically say, 'You're joking, right?' " one industry executive said.

But Democrats want to keep the higher tax on sales of investment partnerships, arguing that financiers would not be taxed at a higher rate for any money of their own put into building their businesses. Instead, they would no longer pay a lower rate for profit earned from the investments of others.

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