In an attempt to right-size a widely perceived source of income inequality in the U.S., new legislation that aims to close a tax loophole utilized by fund managers emerged Thursday in the Senate Finance Committee.
The committee’s ranking member, Ron Wyden, D-Ore., introduced the Ending the Carried Interest Loophole Act. Carried interest is a type of compensation a fund manager gets for investment management services.
Under the current arrangement, the fund manager would not usually get taxed when a profits interest — the right to receive future profits from a partnership — is issued. The fund manager now only pays taxes when income is realized by the partnership sometime in the future, which could be years later, often when the investment is sold, Wyden’s explanation of the bill says. This special arrangement defers tax and allows the income to be taxed at a 23.8% rate instead of the top rate of 40.8% for wage-type income, the office said in a press release and statement accompanying the legislation.
“One of the most indefensible loopholes in the tax code allows wealthy hedge fund managers to be taxed at lower rates than cops and nurses,” Wyden stated.
The ranking member noted that other bills that go after the loophole fall short, as they “only address half the problem” while his goes all the way.
His statement made clear he wanted to ensure “hedge fund managers and private equity CEOs pay their fair share in taxes” at a time when there are great divides in income levels in the country.
The bill would require fund managers to recognize annual compensation that would be taxed at ordinary income rates by preventing the deferral of tax payments. It would do so by “decoupling” income from future sales to investors by treating the transaction as happening outside the partnership between fund managers and investors.
Compensation would no longer be treated as income from the partnership, subjecting it to higher wage taxes.
To prevent double taxation from the new treatment of lower-taxed income to wage-like income, the bill would allow a fund manager to realize a long-term capital loss equaling the annual compensation, offsetting the capital gain from the investment sale.
Wyden’s office explained a situation wherein a fund manager getting 20% carried interest for managing $100 million in investors’ capital would pay the top ordinary income tax rate of 40.8%. If the interest rate for the tax year is 14%, the fund manager would then pay taxes on $2.8 million in compensation under the legislation.
“Senator Wyden has been working on proposals to close loopholes in the tax code for some time; this is one piece of that larger effort,” a spokeswoman for the senator told ThinkAdvisor.
President Donald Trump had indicated on the campaign trail he was willing to address the loophole.
“The administration has not indicated support for the bill,” the spokeswoman said.
The Hedge Fund Association did not immediately have a response to the legislation. It is also not known if the bill enjoys bipartisan support at this time.