Effort to increase taxes on 'carried interest' falls short again
During the 2008 presidential campaign, Barack Obama pledged to tax carried interest at the same rate as regular income, rather than at the lower capital-gains rate, as is currently the case.
What is carried interest? Private-equity firms (which buy, invest in, help manage and eventually sell companies) and hedge funds (which invest in a wide variety of markets) are run by managers on behalf of outside investors. When profits from a firm's investments are disbursed, they are typically distributed according to each investor's stake. This income is taxed on each individual's tax return, usually at the capital-gains rate of 15 percent.
Fund managers may receive some income this way, but there's a separate stream of income that is usually more lucrative for them. Usually they get 20 percent of the profits as a performance-based bonus, "carried over" for years at a time (thus the name, "carried interest"). This payment is then taxed at capital gains rates of 15 percent -- less than if it were salary or wages.
The hefty tax rate advantage for carried interest has spawned criticism. The Congressional Research Service says the dispute boils down to opposing views of what carried interest represents. Obama and his allies say carried interest is essentially a management fee rather than investment profits from an ownership stake, and should be taxed like regular income. Opponents say it's more like like investment income.
Obama included the proposed change in his budget proposal for fiscal 2013, unveiled on Feb. 13, 2012. Mitt Romney, who co-founded and ran Bain Capital, a private-equity firm, had a lot of carried interest income over his working career, making it a topic of particular interest during 2012.
But neither of these factors provided much momentum for the effort to change the tax treatment of carried interest. The provision did not make it into the biggest tax bill of 2012, the last-minute "fiscal cliff” bill that passed on Jan. 1, 2013. So we rate this a Promise Broken.
Text of H.R. 8 ("fiscal cliff" bill)
House Republican Conference, summary of H.R. 8 ("fiscal cliff” bill), Jan. 1, 2013
Urban Institute-Brookings Institution Tax Policy Center, summary of fiscal year 2013 presidential budget proposals, accessed Jan. 2, 2012
Congressional Research Service, "Taxation of Hedge Fund and Private Equity Managers," July 8, 2008
PolitiFact, "Barack Obama says Mitt Romney received carried interest, a tax 'trick,'" July 18, 2012
It's a long shot
In keeping with other proposals to raise taxes on the wealthy, Barack Obama campaigned on a promise to tax carried interest at the same rate as regular income.
Carried interest is a way of compensating executives by giving them ownership stakes, or "interest," in a business. Carried interest is taxed as a capital gain, which has a lower tax rate than ordinary income.
Hedge fund and private equity fund managers who work as partners are compensated in way that takes the form of "interest" in a given business. Instead of taxing this compensation as normal income, the tax code considers it a long-term capital gain taxed at 15 percent. Given that the top tax rate for ordinary income is 35 percent, that can be quite a savings for high earners.
President Barack Obama included the proposed change in his budget proposal for fiscal 2013, unveiled Feb. 13, 2012. But the chances of winning on this issue in an election year are not high.
"Anything that has anything to do with taxes is going to be highly sensitive, and we already know carried interest is sensitive," said Ed Karl, vice president for tax at the American Institute of CPAs. "Will it be enacted? There's a good chance that very little will be enacted this year."
Steve Rosenthal, visiting fellow at the Urban Institute-Brookings Institution Tax Policy Center, gave it slightly better odds. Rosenthal, who opposes the capital gains treatment of carried interest, said he thinks the carried-interest loophole will eventually be closed despite a skillful lobbying campaign to preserve it. "Whether it happens this year or next year, I can't say … It's almost a crap-shoot."
Defenders of the tax treatment have argued that any changes should be part of a larger review of capital gains taxes, including in other industries such as real estate, Rosenthal said. "It's a fantastic lobbying strategy that has just tied carried interest in knots."
Eventually there might be a year-end deal that would include treating part of what is now taxed as carried interest as ordinary income but not all of it, he said, but probably not until after the election if at all. "It's 50-50 at best."
If that comes to pass before the end of Obama's term, we'll re-rate this promise, but for now we consider it Stalled.
Telephone interview with Ed Karl, vice president for tax at the American Institute of CPAs
Telephone interview with Steve Rosenthal, visiting fellow at the Urban Institute-Brookings Institution Tax Policy Center
Carried interest tax provision makes it into jobs bill
President Obama proposed a tax on carried interest during the campaign, and the idea appears to be headed for law.
Never heard of carried interest? It's a way of compensating executives, so that instead of wages or a salary, they get "interest" in a business. Income from that interest is taxed at a lower rate than regular wages. The Treasury Department has said the practice is growing among large private equity firms.
Democrats included the measure in the American Jobs and Closing Tax Loopholes Act, which extends measures for economy recovery, such as unemployment insurance and stimulative tax cuts.
The carried interest provision is expected to increase revenues and was included in the bill to offset its cost. House Ways and Means Chairman Sander Levin, D-Mich., and Senate Finance Chairman Max Baucus, D-Mont., said in a statement that the bill would "close tax loopholes for wealthy investment fund managers."
This is substantial progress on this promise. But until the bill passes though, it remains In the Works.
Thomas, the American Jobs and Closing Tax Loopholes Act, accessed June 3, 2010
CQ, 'Carried Interest' Tweak Included as Key Offset, May 20, 2010
U.S. Senate Committee on Finance, Baucus, Levin To Release Joint Legislation To Create Jobs, Extend Tax Cuts for Families and Businesses, Support Americans Looking for Work, May 20, 2010
Proposal would force some executives to pay higher tax rates
Maybe it would help if you pretend you're an accountant while you read this.
Here goes: Some professionals who work as partners are compensated in way that takes the form of "interest" in a given business. Instead of taxing this compensation as normal income, the tax codes consider it as a capital gain and tax it at a lower rate.
President Barack Obama's proposal would change the law so this form of compensation would be taxed as regular income.
"The recent explosion of activity among large private equity firms has increased the breadth and cost of this tax preference, with some of the highest-income Americans benefiting from the preferential treatment," said the U.S. Treasury Department in its explanation of the proposal, which recommends that the rule change in 2011.
Congress must first approve this change if it is to become law. We rate it In the Works.
U.S. Treasury Department, General Explanations of the Administration"s Fiscal Year 2010 Revenue Proposals , May 2009
Tax Policy Center, Tax Proposals in the 2010 budget , accessed Oct. 2, 2009