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Debate: Should Carried Interest Tax Loophole Be Eliminated?

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The carried interest rules are a set of tax rules that offer favorable tax treatment when a partnership interest in a private equity or hedge fund in exchange for future services to the partnership. In lieu of cash compensation, the services entitle the individual to receive a share of future partnership profits.

Instead of being taxed for compensation at ordinary income tax rates, recipients of future partnership profits are usually entitled to pay tax at the long-term capital gains tax rates, which are, of course, substantially lower than ordinary income tax rates.

Under the 2017 tax reform legislation, a three-year holding period requirement applies to certain recipients in order to gain long-term capital gains treatment. President Joe Biden is proposing to permanently eliminate these carried interest tax rules so that recipients would be required to pay ordinary income tax rates on amounts received.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about eliminating the current beneficial tax treatment under the carried interest rules.

Below is a summary of the debate that ensued between the two professors.

Bloink: The carried interest rules are yet another tax loophole to allow wealthy private equity and hedge fund managers to avoid paying their fair share of income taxes. This is a change that should have been implemented years ago, and it’s about time we started focusing on the nitty-gritty ways wealthy taxpayers manage to avoid almost all tax liability. 

Byrnes: It makes complete sense that carried interest should be treated as capital gains income — because these benefits are most similar to investment income or a return on goodwill. Biden’s already calling for a long-term capital gains tax rate hike that would cause rates to skyrocket to 39.6% — higher than the current top ordinary income tax rate. Focusing on the carried interest rules is really just a backstop, in case he’s unable to pass the capital gains tax hikes he has in mind. 

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Bloink: Eliminating the carried interest rules would require wealthy taxpayers who typically are able to game the system to pay ordinary income taxes on their compensation just like all the other hardworking Americans who don’t have the resources to benefit from these complex rules. If we’re looking for ways to increase revenue while limiting tax hikes on the middle class, this is a prime way to get where we need to go. 

Byrnes: We’ve already limited the carried interest “loophole” by imposing a three-year holding period requirement in order to gain long-term capital gains qualification (even longer than the traditionally applicable one-year holding period requirement). Bottom line? Eliminating the carried interest rules would give taxpayers a disincentive to remain invested in businesses that keep this economy moving.

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Bloink: All of the economic stimulus efforts that we’ve implemented over the past year or so are paying off. However, the reality is that we have to fund those efforts somehow. If we’re talking about job creation and economic growth, eliminating the carried interest rules in favor of actually encouraging investment in our infrastructure is the way to go. We’ll be creating jobs while also investing in education, rebuilding public roads and transportation systems.

Byrnes: We’re at a turning point right now. With hopes high that vaccine efforts will pay off, we need to be looking toward the future — and that means encouraging investment in our economy and the businesses that keep it running. Eliminating this valuable tax benefit at this moment in time would be a step in the wrong direction and could substantially hamper our economic recovery.

Their Votes:

Bloink

Byrnes

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