By Laura Saunders
The August 6 Tax Report on the controversial “carried interest” issue attracted many comments. Some readers defended the provision’s current generous tax treatment and said changing it could damage the U.S.’s ability to create jobs and compete internationally.
“Does America really want to drive away the private equity industry when international competitiveness and international demand for U.S. products is more threatened than ever?” said Bernard Peperstraete of NGN Capital in New York.
Mark Heesen, president of the National Venture Capital Association, agreed. In a statement to the Wall Street Journal, he said, “Continuing to apply a capital gains tax rate to carried interest earned by venture capitalists who invest long-term to build new companies and create jobs is not only appropriate by definition, but from a public policy perspective it is paramount to U.S. economic recovery as we desperately need to encourage - not discourage – this high growth activity.”
Others disagreed. An investment manager from Hilton Head, S.C. said, “The carried-interest rules benefit me personally as a manager of investment partnerships. But even I can’t argue that they are sound tax policy.”
A few readers had technical questions. “Do you think REITs and Master Limited Partnerships would be included in changes on carried interest?” asked one adviser.
Independent tax analyst Robert Willens said no, because the dividends from most REITs and MLPs are already taxed at ordinary income rates. “They aren’t part of the discussion on carried interest,” he said. Neither has there been talk of changing the capital gains tax rates for timber REITs.
While some believe all carried interest should be taxed as ordinary income, others suggested a less radical approach. It is to tax the original award of carried interest at ordinary income rates but then allow further appreciation to be taxed as a capital gain.
Here’s an example: Say that Ted, Joe and Jane form a partnership. Ted and Joe each put in cash in return for an 80% of the profits, while Jane contributes her expertise in return for a 20% share. Jane would be taxed at ordinary income rates on her 20% profit share when she receives it. After that, her future appreciation would be taxed as capital gain.
“That would treat carried interest like executives’ restricted stock,” said Willens of the suggestion.