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House Democrats to push for tax hike on private-equity chiefs

October 14, 2009 | 12:27 pm

As the fortunes of private-equity firms improve with rebounding financial markets, House Democrats are renewing a push for a long-sought tax increase on the industry.

From Bloomberg News:

Matthew Beck, a spokesman for the House Ways and Means Committee, said the panel will revive an effort to raise the 15% tax rate on “carried interest,” a term for the share of [an investment] fund’s profit that is paid as compensation to its executives.

That portion of an executive’s pay, now taxed at lower capital gains rates, would be subject to income tax rates of as much as 35%.

“There is strong support for taxing carried interest as ordinary income and I expect this issue to move forward in the coming months,” Beck said.

Managers of private-equity firms, hedge funds, venture capital firms and other investment partnerships typically use the "2-and-20" compensation structure: They earn an annual fee of 2% of assets under management and then take 20% of any profit above preset levels. The rest goes to the investor-clients who put up the capital the managers invest.

The 20% profit is known as carried interest, and is treated as a capital gain for tax purposes if the underlying return was generated on investments held more than a year.

Many Democrats say that such compensation should be classified as regular income and taxed accordingly. The House in June 2008 passed a bill mandating that change but Republican opposition scuttled it in the Senate.

Now, with Democrats in control of the House, Senate and the White House, carried interest is a ripe target as Washington looks for ways to boost revenue.

From Bloomberg:

Ways and Means Committee Chairman Charles Rangel, a New York Democrat, and other Democrats including Michigan Representative Sander Levin say [carried-interest] fees are more like wages than capital gains because executives usually haven’t risked their own capital.

Revenue from the tax proposal may be earmarked by House Democrats to help pay for renewal of tax subsidies designed to help economic recovery. For example, Rangel said lawmakers should extend an $8,000 tax credit for first-time homebuyers, and the White House is pushing renewal of an incentive that lets companies use current losses to get refunds for past taxes.

Arguing against the tax change, the private-equity industry in the past has countered that fund managers should qualify for the lower capital gains tax rate on carried interest because they "act as owners, not employees" and "bear significant economic risks."

This time around the industry also will try to play the economy card, asserting that after private-equity firms buy companies they make them better (a debatable point, to say the least).

Douglas Lowenstein, president of the Private Equity Council, told Bloomberg that as the economy begins to recover a “tax increase on growth investors with a demonstrated record of building stronger companies and creating new jobs would be exactly the wrong policy at the wrong time.”

-- Tom Petruno

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