Illustration: Annelise Capossela/Axios
We're more than a decade into the political debate over how to tax carried interest, the profits earned by private fund managers on others investors' capital. And somehow the proposals are getting worse.
Background: For the uninitiated, carried interest is usually taxed as a capital gain, rather than as ordinary income.
Driving the news: A plan by House Democrats would significantly increase the amount of time the investment must be held to qualify for long-term capital gains tax treatment.
- The current hold time is three years (increased via the 2017 tax bill), which would be extended to five years. This had been expected.
- What wasn't expected is that the "clock" wouldn't begin until "substantially all" of the relevant fund's committed capital is invested, which lawyers suggest would be interpreted as around 80%.
The net result, in addition to increased federal tax revenue, would be to misalign general partners and limited partners (i.e., public pensions, university endowments, etc.).
- Imagine a private equity firm raises a new fund today and buys Axios tomorrow. It plans to invest the fund over four years, and hits the 80% threshold in early 2025.
- It now must hold Axios for a total of nine years, until 2030, to recognize the beneficial tax treatment. That's a very long time by private equity standards, and means that firms may pass up lucrative exit opportunities in the pursuit of future tax advantages. It also means there would be different tax rates for investments made early in a fund cycle and later in a fund cycle.
This isn't about protecting private equity or venture capital. My position on carried interest has been steadfast, agreeing with Presidents Obama, Trump and Biden that it should be treated as ordinary income.
- But that's because I believe it is ordinary income, a fee for services.
- Whether you agree or disagree, it's hard to see that opinion being swayed by if a company is bought at the beginning or end of a fund cycle.
Caveat: The entire Biden economic agenda, including tax reform, remains imperiled. So this might be a tempest in a shattered teapot.
Bottom line: I've previously referred to carried interest tax treatment as a political football whose continued controversy benefits both sides. What we're seeing now, though, is a fumble.