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House Democrats Float Bill to Close Carried Interest Tax Loophole

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Three House democrats floated legislation Tuesday to close the carried interest loophole, which they say is a tax dodge for wealthy private equity and hedge fund managers.

The Carried Interest Fairness Act would tax carried interest compensation at ordinary income tax rates and treat it as wage income subject to employment taxes.

The bill is sponsored by Rep. Bill Pascrell, D-N.J., chairman of the House Ways and Means Subcommittee on Oversight; Rep. Andy Levin, D-Mich.; and Rep. Katie Porter, D-Calif.

As it stands now, the lawmakers explained, the carried interest loophole allows Wall Street firms — like private equity and hedge funds — to pay the lower capital gains rate on their income (15% or 20%), rather than paying ordinary income  tax rates (up to 37%).

“The capital gains break would still apply for those who truly put money at risk, such as private equity partners who invest their own money in their funds,” the lawmakers said. “But all income from managing a firm’s assets would be taxed at ordinary rates.”

Pascrell said Tuesday in a statement that “Over the last four years, our tax system has continued to become more unfair. Our two-tier tax code, with one code for working class Americans, and another full of special breaks for the people at the very top, has destroyed public confidence in our tax structure that must be restored.”

The carried interest loophole, Pascrell continued, “has allowed private equity tycoons to pay lower tax rates than their secretaries. This year, millions of Americans are struggling to survive and are entitled to a fairer tax system. This loophole has survived too long and we are going to push hard to see that it is finally closed.”

Andy Friedman, founder and principal of The Washington Update and a former tax attorney, told ThinkAdvisor Wednesday in an email that the Carried Interest Fairness Act bill ”is the latest of a number of proposals to treat the sale of a carried interest as giving rise to capital gain. All have failed, in part due to pushback from the financial services sector.”

Friedman opined that while “there is no chance of this bill passing as a standalone measure, it is possible the provision could be included as Congress takes up Biden’s tax proposal.”

The Congressional Budget Office has estimated that closing the loophole would produce $14 billion in revenue over 10 years, while other budget experts have suggested it could bring in more than 10 times as much, according to the lawmakers.

In early January, the IRS released regulations that bar money managers from using business entities known as S corporations to take advantage of an exemption to the 2017 tax law’s rules for taxing carried interest, according to Bloomberg.

“The regulations address what some tax policy experts see as a mistake in the 2017 tax overhaul that allows hedge fund managers to exploit a loophole to avoid paying higher taxes on their investments,” according to Bloomberg.

“The carried interest loophole is a windfall for elite private fund managers that does nothing for American families,” Porter said in the statement.

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