Congress eyes new tax on private equity
Last week staffers on Congressional tax-writing committees held a closed-door meeting with various tax experts (lawyers and academics, primarily) to discuss changing the way private equity firms are taxed. To boil down a complicated topic, partners in private-equity firms - which include buyout funds and venture capital firms - typically pay ordinary income tax only on their management fees, usually 2% of assets under management. Their “carry,” or their share of any profits they generate for their investors, are taxed as long-term capital gains. (That’s a 35% tax rate for rich people earning ordinary income versus 15% for all long-term capital gains.)
It doesn’t make a hell of a lot of sense since the buyout and VC partners aren’t investing any money, just their time and effort — which is kind of what I invest when I go to work every day. (If they do invest actual money, that’s a different story, of course.) Henry Blodget has a good take on the topic in his blog, the Internet Outsider, and a New York Times editorial in April urged Congress to tackle this issue, arguing that capital gains receive “excessive” preference in the current tax code. I also have an article in the current issue of Fortune that discusses how VCs are trying to distance themselves from their buyout brethren, even though their partnerships are structured exactly the same way.
Anyway, at this closed-to-the-public meeting, the staffers (no lawmakers attended) took a mostly fact-finding approach, suggesting they haven’t decided what if any proposals they’ll put forward to change how firms are taxed. They also showed an interest in broader issues, like offshore tax shelters, a key device used by hedge funds. They heard from tax gurus including Jack Levin of Kirkland & Ellis, Dana Trier of Davis Polk, Victor Fleischer of the University of Colorado, Arturo Requenez of McDermott Will & Emery and Stuart Leblang of Akin Gump.
When I’ve discussed this issue with VCs and buyout types, the only question they keep asking is, Do you think anything will come of this? The answer seems to be that Congress will take its sweet time with this issue, usually a prescription for inaction.
(Should “carry” be taxed as ordinary income? Have your say in my comment section or in this poll.)
The article states their “carry” is the private-equity firm’s share of any PROFITS they generate for their investors. It does not say their share of equity. Profits to me would mean they get a portion of the net profits at the end of the year. That would mean cash, not equity. That is NOT capital gains. However, being a business owner, I will look into changing my company structure to reduce my profits to a tax rate of 15%. Why is it that everything is turned into a class argument to defend wealthy people? Heaven forbid if we increase the tax rate the wealthy pay to the same rate everyone else pays. We wouldn’t want them to starve. I guess we should let the middle class pay the taxes and drive the economy.
Just an aside — VCs and Private Equity firms typically carry a different fee structure than the hedge fund 2+20 fees.
Its complex, but here’s an oversimplification: Its often a 2.5% management fee while the fund is investing, sliding down towards 1% afterwards. And the 20% is more like 100% back to the investor until they are made whole, then an 80/20 split (til they recieve 2X), than a 70/30 or 60/40 beyond that
It varies, but its a much less simple formula than the hedgies get . . .
Of course, VCs and PEs should pay ordinary income tax on ‘carried interest’ (Fees). If as a previous poster suggested I took a bank loan to fund an investment and it tanked, I would still be responsible for paying back the loan unlike VCs and PEs. They do not have their own capital AT RISK to garner the capital gains rate. If they want to get a 15% rate on their carry, they should put up their own money not their investors.
Private equity investors who receive a share of the profits should be taxed at the same rate that I get when I receive a bonus…at my marginal bracket. To do otherwise is unfair. Imagine an employee choosing whether to take a bonus in shares of a company or in cash with the only difference being one is taxed at 35% and the other at 15%. This is plainly unfair.
Absolutely not. When you get a bank loan to make an investment for your business, your return on your investment should be taxed as a capital gain (Sure you are using the bank’s money and only putting in your “time and effort”) and NOT as ordinary income. This tax is absolutely backward thinking. Anytime a group of entrepeneurs / innovative people find a way of making themselves money and achieving the American dream, all of the haters / lazy people who feel a sense of entitlement believe we should tax them because it is “fair.” Horrible.
For simplicity sake, IMHO, Hedge funds and Private Equity are no different than Mutual Funds. Mutual funds are investment vehicles for average joe’s like you and I. Hedge Funds and Private equity are investment vehicles for the wealthy. I think Mutual Fund profits are taxed as long term capital gains, therfore so should Hedge Funds and Private Equity. We need to be careful what we wish for in that if its determined that Hedge Funds and Private Equity are to be taxed at ordinary income, than what is to stop them from taxing Mutual Funds as ordinary income as well?
Absolutely not. Why must a wealthy person pay ordinary income on money that is clearly a Long Term Capital Gain? The Democratically controlled Congress is bent on raising taxes, stifling investment and hurting the economy to appease their constituents! Go Rudy Giuliani!! And by the way, I am not a wealthy individual by any means, I am simply a smart business person who understands that increasing taxes stifle investment which ultimately stifles our economic growth and sends more jobs overseas.
The root cause of this situation is that we have a completely out of control tax code that is way too complicated. It is these types of situations that take power away from US citizens and into the hands of politicians. This is how special interest is created. The solution should not be to add yet another special set of complicated laws to our tax code. We should seek to abolish the oppressive laws that got us to this point. It’s time for something new. Check out the FairTax at http://www.fairtax.org
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Wall Street watchers think of capital markets and financial players out west as being on the "other" coast. That's not how it's viewed in the Pacific time zone. From the venture capitalists of Sand Hill Road to the bond kingpins of Orange County to the corporate finance department at a certain software company in Redmond, Wash., there's plenty going on "out there." Adam Lashinsky should know. A native of Chicago, he has covered West Coast finance for a decade, with an emphasis on money matters in Silicon Valley. If it involves money and it's happening west of the Mississippi, look for it in Go West. 
How about a discussion to put in a tax system that would allow “transparency”.
Eighteen years and over twenty million in Ivy League research has provided an answer that can be finely tuned.