Senate Unveils Carried-Interest Compromise

Jun 10 2010 | 12:54pm ET

Senate Democrats this week finally unveiled their plan for closing the carried-interest tax loophole, promising to do so on terms more favorable to the alternative investment industry than the House of Representatives plan.

Under the Senate plan, part of a larger $140 billion unemployment benefits and tax bill, hedge and private equity fund managers would pay the full ordinary income tax rate on just 65% of the performance or incentive fees they earn, with the remainder taxed as capital gains. The House bill—backed by President Barack Obama—would offer no such break; under the current law, all carried interest is taxed as capital gains.

Venture capitalists would do even better under the Senate proposal, which was watered down to attract the support of a half-dozen Democrats who balked at the original House bill. Carried interest on investments held for at least seven years would be taxed at 31%, less than the 33% effective rate on hedge and private equity fund managers.

Despite the compromises, there is no guarantee the bill will pass. It needs at least one Republican supporter if it is to avoid a filibuster, and none have yet signed up. The proposal could undergo still further changes to alter that fact.

Republicans blasted the bill as a “joke” and warned it would increase the deficit. But even the Alternative Investment Management Association, one of the largest hedge fund lobbies, said it wouldn’t adversely affect U.S. competitiveness in the alternative investments space.

While hedge funds are obviously opposed to the tax hike, AIMA’s Todd Groome said they won’t flee the jurisdiction if it comes to pass.

“I don’t think you change your life over that,” he told Reuters of closing the carried-interest loophole. “It’s a big deal and we care about it. It just looks like it’s one of those things that’s a slow march in that direction.”

Sen. Charles Schumer (D-N.Y.), who represents the largest hedge fund center in the world, agreed, telling the New York Daily News that he is “not worried” about the bill’s effect on New York’s competitiveness.

“The proposal that [Sen. Max] Baucus made goes across the board,” he said. “It affects private equity and hedge funds. It affects real estate. It affects venture capital, and that’s how it should be.”

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