Carried interest sparks bipartisan tax debate

Jan 22, 2012 @ 12:01 am

By Mark Schoeff Jr.

When millionaire GOP presidential candidate Mitt Romney last week estimated his federal tax rate at 15%, he drew howls of criticism from both Republicans and Democrats, and put a controversial tax treatment for private-equity returns back on the front burner in Congress.

The flap drew attention to so-called carried interest, which allows private-equity principals to pay taxes at the capital gains rate — currently 15% — on the 20% profit allocation that they can take out of the investments made by their firms. Most working Americans' earnings are taxed as ordinary income at a rate that can be as high as 35%.

Mr. Romney's disclosure provided political fodder for both Republicans and Democrats. His Republican opponents' increased their demands on him to release his tax returns, while Democrats questioned how a person as wealthy as the onetime governor of Massachusetts and former chief executive of Bain Capital LLC could pay such a low rate.

Last week, Rep. Sander Levin, D-Mich., ranking member of the House Ways and Means Committee, reintroduced a bill that would tax carried interest as ordinary income. Carried-interest reform also might be offered to help pay for extending a payroll tax deduction for workers that is set to expire soon. In addition, President Barack Obama may put carried-interest provisions in his upcoming budget.

Although reform legislation on carried interest has passed the House four times since 2007 only to die in the Senate, the turmoil over Mr. Romney's tax situation gives the issue new momentum, observers said.

“It could be an area in which the two parties could agree,” said Robert Cudd, a partner at Morrison & Foerster LLP. “A slimmed-down carried-interest bill — focused on the private-equity industry — now has legs.”

The current debate differs from previous tussles over carried interest because Mr. Romney puts a human face on an esoteric topic. Mr. Romney's campaign did not respond to a request for comment.

“There is now a real-life example,” said Brad Van Buren, a partner at Holland & Knight LLP. “You'll see how this carries through to his tax return. This might resonate more with the public.”

Mr. Levin is trying to leverage the blow-up.

“When Gov. Romney says his tax rate mostly reflects returns on his own investment, he needs to clarify how much this is truly money that he invested himself and how much is carried-interest income that he earned managing other people's money,” Mr. Levin said in a statement. “Conflating the two is at the heart of this tax equity debate.”

Mr. Levin's Senate colleagues didn't act on carried interest when it was proposed as a way to pay for a package of tax extenders in 2010, when Democrats had a 60-vote majority.

Dean Zerbe, managing director of alliantgroup, expects some Democrats to promote carried interest in the same way that they push a millionaires' surcharge, which has consistently failed.

“You can anticipate a series of amendments similar to last year's tax increase on millionaires,” said Mr. Zerbe, who was the Republican tax counsel on the Senate Finance Committee when a carried-interest tax was proposed in 2007.

Even Democrats who are eager to use carried interest as an example of how the top 1% of earners have advantages in the economic system not available to the other 99% acknowledge high political hurdles.

“We had some folks on our side of the aisle that had concerns about carried interest, especially in the Senate,” said Greg Jefferson, legislative representative for the AFL-CIO. “I'm not sure whether the Romney piece will loosen them up.”

The Private Equity Growth Capital Council is confident that its arguments about the economic benefits of private equity will carry the day.

SENATE ALLIES

“We believe that tax policy should incentivize the kind of entrepreneurial risk taking that private-equity firms undertake every day,” Steve Judge, interim president and chief executive of the council, said in a statement. “While we fully expect the president to include a carried-interest tax hike in his budget as he has in the past, even with the highly charged election year rhetoric, it is uncertain that such a proposal will gain traction this Congress.”

Sens. Charles Schumer, D-N.Y., who represents the state with probably the highest concentration of taxpayers who benefit from the tax treatment on carried interest, Max Baucus, D-Mont., chairman of the Senate Finance Committee, and John Kerry, D-Mass., have been seen as carried-interest allies.

One of Mr. Kerry's aides said that he supported a 2010 bill from Mr. Baucus that would treat 75% of carried interest as ordinary income.

Mr. Schumer's and Mr. Baucus' offices didn't respond to requests for comment.

“Sen. Kerry has worked to close the carried-interest loophole in a way that's fair and which avoids unintended harm to housing or innovation,” Jodi Seth, a spokeswoman for Mr. Kerry, wrote in an e-mail. “This problem exists because of the large differential between the capital gains rate and the top income tax rate.”

Most observers said that any changes in carried interest will have to wait until that broader tax reform debate begins after the election.

“Carried interest will be absorbed in the discussion of whether we continue the 15% capital gains rate,” said Marc Teitelbaum, a partner at SNR Denton U.S. LLP. “No one would want to push [carried interest] to the exclusion of overhauling the tax code.”

mschoeff@investmentnews.com

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