Legislation Introduced to Eliminate Carried Interest Tax Break

Rep. Sander Levin, D-Mich., the ranking Democratic member on the tax-writing House Ways and Means Committee, introduced legislation Tuesday to tax the carried interest earned by hedge fund managers, private equity firm partners, venture capitalists and others at the same tax rates as ordinary income.

Levin had indicated last month that he planned to re-introduce the legislation, which he has introduced several times in the past five years (see Congressman to Re-introduce Bill to Eliminate Carried Interest Tax Break). The issue gained fresh attention with the release last month of Mitt Romney’s tax returns, showing that the Republican presidential candidate’s effective tax rate was less than 15 percent, mainly due to the income he continued to receive from investments he made as the former head of the private equity firm Bain Capital.

Levin said his legislation would fix a tax “loophole” that enables private equity managers to pay reduced tax rates. The elimination of the carried interest tax break was among the proposals in the fiscal 2013 budget plan that President Obama unveiled on Monday (see Obama Proposes Tax Reforms in 2013 Budget). However, previous efforts to eliminate the tax break have been fiercely resisted by the financial industry, particularly by private equity and hedge fund partners who have lobbied heavily to keep it in place.

Levin noted that the tax break enables certain investment managers—including private equity managers—to pay a reduced 15 percent tax rate on income received as compensation, rather than ordinary income tax rates up to 35 percent that all other Americans pay.

In exchange for providing the service of managing their investors’ assets, fund managers often take a portion of a fund’s profits, or a carried interest, usually equal to 20 percent of such profits.  The bill clarifies that this income is subject to ordinary income tax rates rather than the much lower capital gains rate. 

"There is absolutely no reason why income earned for managing other people's money shouldn't be taxed in the same way as income earned teaching or working in a factory," Levin said in a statement. "This loophole for years has unfairly enabled some of the highest-paid individuals in the country to sharply reduce their tax bills and it is time to close it once and for all.”
His office argued that the bill would not affect investors or hurt economic growth. Any person or institution who invests money in a fund whose managers receive a carried interest would continue to pay the capital gains rate on their profits. The bill explicitly protects the investments that fund managers make themselves. To the extent they have put their own money in the fund, managers still get capital gains treatment, but to the extent they are being compensated for managing the fund, they would have to pay ordinary income tax rates like other service providers.