Up in the air

Washington seems to have become confused on the issue of treating carried interest as ordinary income, which would ratchet up the tax rate on carry to almost 40 percent. For GPs, this could be a sign that a tax increase on carried interest is not inevitable.

 

President Barack Obama has consistently hammered on the issue and reminded the nation in his State of the Union speech Wednesday night that investment fund managers are part of his rogue's gallery of those who will not be seeing any tax relief: 

 

“At a time of record deficits, we will not continue tax cuts for oil companies, for investment fund managers, and for those making over $250,000 a year. We just can't afford it,” the president said. 

 

Apparently, investment fund managers face some pain. One can infer from Obama's 2010 budget proposal the “tax cut” for investment fund managers to which he referred was the longstanding treatment of carried interest as capital gains rather than ordinary income. Obama would like to take a portion of GPs' carry to fund tax cuts for the middle class and small businesses that are part of the US House of Representatives’ Tax Extenders Act of 2009, which the House passed in December. 

 

Despite the President's confident reminder on the issue Wednesday, the US Congress does not seem as resolved to settle the carry issue just yet. 

Earlier this week, Senator Debbie Stabenow, a member of the Senate Finance Committee, said in an interview: “I don’t think [a tax hike] is going to be part of the Senate bill… While members of the committee have brought it up, it won’t be part of any bill we pass.” Stabenow, a member of Obama's Democratic Party, was talking to Crain's Detroit Business. 

The committee Stabenow is part of, the powerful Senate Finance Committee, is considering legislation already passed by the House of Representatives that would raise the tax rate on carried interest as high as 39.6 percent,  so it would seem that she speaks with some authority (See “US Senator: Carry tax hike won’t pass”). 

Meanwhile, a representative for Senator Max Baucus, the chairman of the committee, will only state, somewhat enigmatically, that Baucus “believes that carried interest should be addressed within the context of overall tax reform”.

Even if Baucus and Stabenow, both Democrats, could agree on whether the tax treatment of carry should be changed, the possibility of getting such legislation approved on the Senate floor might be slimmer now that Massachusetts has elected Scott Brown to take Senator Edward Kennedy’s seat, as Kevin Ley writes in “Brown out”.

GPs are divided on the topic of treating carried interest as ordinary income. Many GPs, including industry lobby the Private Equity Council, have denounced the idea, warning it would weaken US firms' competitive positions. But some other GPs, notably Apollo Management founder Leon Black, have taken more tepid views of the issue.

“It wouldn't be the worst thing in the world to have some adjustment,” Black said onstage at a recent private equity conference in New York. “I don't think it should be ordinary income, but maybe something in between.”