U.S. Sens. Ron Wyden (D-OR) and Sheldon Whitehouse (D-RI) introduced a bill to close the carried interest loophole often used by hedge fund managers.
The lawmakers described the carried interest loophole as the “re-characterization of income from wage-like income to lower-taxed investment income and deferral of tax payments.” The Joint Committee on Taxation (JCT) estimates that the bill would raise $63 billion over 10 years. There have been previous bills related to this subject, but they did not address deferral of tax payments, the lawmakers said.
“One of the most indefensible loopholes in the tax code allows wealthy private equity managers to be taxed at lower rates than nurses treating COVID patients and avoid paying any tax year after year after year. This is an issue of fairness,” Wyden, chair of the Senate Finance Committee, said. “Importantly, my bill closes the entire loophole—private equity managers will no longer be able to defer paying tax for years, if not decades. Nurses treating COVID patients can’t defer paying taxes for years—neither should the private equity managers.”
With this bill, fund managers would be required to recognize annual compensation that would be taxed at ordinary income rates and subject to self-employment taxes. Annual compensation would be determined using the estimated forgone interest on an implicit interest-free loan from investors to the fund manager at a prescribed interest rate.
Also, the bill treats transactions between fund managers and investors as occurring outside the partnership, decoupling compensation from future sales of investments and ensuring the value of the fund manager’s carried interest is taxed from the outset. Currently, the fund manager’s carried interest is taxed as income from the partnership, which allows the deferral of tax payments until future investment sales.
“Americans have had enough of hedge fund tycoons using this special carve-out to pay lower tax rates than their drivers. We need to rebuild our tax code to guard against the ultra-rich and corporations scheming to avoid paying their fair share. Our bill is a good place to start,” Whitehouse said.
To account for the re-characterization to wage-like income and avoid double taxation, the fund manager would also realize a long-term capital loss equivalent to the annual compensation, which could offset the fund manager’s future long-term capital gain from sale of an investment. For example, if the fund manager receives a 20 percent carried interest in exchange for managing investors’ capital of $100 million, and the interest rate for the tax year is 14 percent, the fund manager would pay the top ordinary income tax rate of 40.8 percent tax on $2.8 million in deemed compensation.
“The carried interest loophole is an absurd, regressive loophole with no credible economic justification. Millionaire fund managers do not deserve preferential tax treatment on income they earn managing other people’s investments. It’s time for Congress to pass the Ending the Carried Interest Loophole Act and close this ridiculous loophole that has allowed some of the wealthiest people in the country to cut their tax bill nearly in half,” Morris Pearl, former managing director at BlackRock and Chair of the Patriotic Millionaires, said.