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VCs Object to Tax on Carried Interest

May 20, 2010

Hedge fund managers and private equity firm partners have been fighting efforts in Congress to raise the tax on carried interest from capital gains rates, and venture capitalists have now fired an opening salvo against the latest legislation.

House Ways and Means Committee Chairman Sander Levin, D-Mich., and Senate Finance Committee Chairman Max Baucus, D-Mont., introduced the American Jobs and Closing Tax Loopholes Act of 2010 in the House and Senate on Thursday (see Legislation Introduced to Extend Unemployment Insurance and Tax Breaks). The bill would extend a host of expiring and already expired tax breaks for both individuals and businesses, including the research credit and the ability to deduct state and local sales taxes. The bill would also extend unemployment insurance and the 65 percent COBRA subsidy for health insurance for the unemployed through the end of the year.

But to pay for all its many provisions, the bill would also close a number of loopholes, including one that has allowed private equity firm partners, hedge fund managers, real estate investment trust partners, and many venture capitalists to pay taxes of only up to 15 percent on carried interest when taxed as capital gains, as opposed to the maximum of 35 percent when taxed as ordinary income, which would climb to 39.6 percent next year.

The National Venture Capital Association is one of the groups lobbying to keep that loophole open, insisting that it's not really a loophole. NVCA president Mark Heesen issued a statement reacting to the new legislation. "The provision in HR 4213 to tax 75 percent of venture capital carried interest at ordinary income rates and 25 percent at capital gains rates will more than double the taxes that long term investors pay when they build successful companies and create jobs,” he said. “While this provision is movement away from a pure change to ordinary income, evidencing a House recognition that this type of long term investment is critical to US economic growth, it by no means creates enough of a differential to continue to encourage long-term investment in America’s startup companies. We hope that this provision can be amended so that there is a meaningful differential — and a real incentive for venture investors to work with entrepreneurs to continue to build America's next generation of employers.”

"The venture industry takes serious issue with the title of this bill for two reasons. First, referring to the carried interest tax structure as a 'tax loophole' is untruthful,” he added. “The capital gains treatment of carried interest has been a legal part of the Tax Code for decades. Additionally, to characterize this as an 'American Jobs' bill is ironic as doubling the taxes on job creators will result in less jobs, not more, effectively negating any provisions in the bill that will actually support U.S. employment numbers. The venture capital community has continued to create thousands of U.S. jobs each month throughout the recession without any type of government subsidies and plays a critical role in our country's economic growth and ongoing global competitiveness. This role needs to be supported by Congress.”

“We urge members of the House of Representatives and those in the Senate working on legislative language of their own, to seriously reconsider the carried interest provision and redraft the language so that a meaningful differential is maintained and long term investment in start up companies is encouraged at a time when America needs jobs the most.”

Congress has abandoned efforts to raise taxes on carried interest in the past amid intense lobbying by the financial industry, but with many constituents clamoring for extension of the various tax breaks in the bill, and others demanding extension of unemployment benefits, Congress will be hard pressed to pay for all those expenditures without a way to raise revenue to offset them. Efforts to crack down on carried interest tax preferences, along with other loopholes benefiting multinational corporations, may finally get passed this time around as Congress comes under increasing pressure to do something to curb the exploding federal budget deficit.

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