Carried Interest Taxation

A few newsworthy events on the Blackstone Bill here:

· Blackstone amended its SEC Filing (see page 37) to disclose the risk associated with the introduction of the Baucus/Grassley legislation.

· Senator Christopher Dodd (D-CT), chairman of the Senate Banking Committee, has indicated that he is considering a review of the Blackstone Bill by that committee to determine its effect on capital markets. Many people affected by any carried interest legislation are constituents of Senator Dodd.

· Representative Charles Rangel (D-NY), chairman of the House Ways and Means Committee, hints that committee could take up review of the Blackstone Bill as early as July.

· The Private Equity Council, an exclusive trade group consisting of the top tier of private equity firms, has hired a lobbyist to represent the trade group on regulatory issues related to the “tax treatment of partnership interests in private equity funds.”

While the Blackstone Bill is getting most of the recent press, it addresses a fairly narrow (although fascinating because of the size of the deals and the personalities involved) subset of the taxation of carried interests–carried interests owned by a publicly-traded entity. We will certainly monitor this debate and that bill’s progress or lack thereof.

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The larger issue that we want to address in this forum is the appropriate tax treatment of carried interests in funds. In many ways, the current debate is a continuation of a long-running issue in the tax world, the taxation of partners who receive interests in a partnership in whole or in part for services rendered. This issue has two parts–

(1) Is a person taxable on receipt of a partnership interest as consideration for services?

(2) Is a person who receives an interest in a partnership in whole or in part for services rendered entitled to the same tax treatment from partnership operations as a person who receives the partnership interest in exchange for capital contributed?

The IRS and taxpayers have debated and litigated the first question for well over 50 years. However, the second question is relatively settled that a person receiving an interest in a partnership for services is just as much a partner and entitled to the same tax treatment from partnership operations as a person receiving a partnership interest for capital contributed. Because the current debate calls both of these issues into question, Congress will have to consider the unintended consequences of such a fundamental change in the taxation of partners and partnerships. We’ll spend some time over the next few days recounting some of this history as a guide to understanding what the future might hold.