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Maryland may become the first state to unilaterally change the tax treatment of carried interest, the investment profits earned by managers of venture capital, hedge, and private equity funds.

Driving the news: The bill, introduced in late January by 19 Democratic co-sponsors, would introduce a 17% tax on carried interest earned by those filing in Maryland. Currently, such carried interest is taxed at the state's 5.75% capital gains rate. Maryland Gov. Larry Hogan, a Republican, has not yet taken a position on the bill.

The proposal, which you can read here, closely mirrors a similar bill that passed last year in New Jersey. For example, both undercut their "fairness" argument by exempting real estate investments.

One big difference is that New Jersey's tax increase only goes into effect if similar statutes are passed in Connecticut, Massachusetts, and New York — in an effort to prevent New Jersey-based firms from relocating. So far, that hasn't happened.

  • Maryland's proposal doesn't need require buy-in for bordering states, nor from the District of Columbia.
  • This could become a significant challenge, if passed, given that so many Maryland venture and buyout firms are located in the D.C. area, and could relocate without causing their employees much inconvenience. A senior executive with one such Maryland firm already told me that his shop would almost certainly pick up and head a few Metro stops south.

Carried interest is arguably a fee for services — profits earned from investing someone else's money — and should be taxed as ordinary income. In fact, that's one of the few areas of agreement on tax policy between Presidents Trump and Obama, even though neither of them got it changed at the federal level (thanks, in part, to lobbying by private equity).

  • As such, Maryland's legislative heart is in the right place here.
  • It's head, however, is a bit tilted. Not only because of the real estate carve-out and disinterest in regional consensus, but also because this would turn carried interest into its own (much) higher tax category, rather than just lumping it into ordinary income.

The hope, therefore, should be that whatever the Democrat-controlled legislature sends to Maryland's Republican governor will be tightened up.

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