Carried Interest Taxation

A lot of news to report surrounding the testimony in Congress yesterday:

• Russell Read, chief investment officer of CALPERS, testified his belief that the private equity legislation's impact of their returns would be negligible.  This testimony undermines claims by private equity  managers that changing the tax rate on managers would hurt retirees by reducing returns on pension investments in alternative investments.  The testimony is also consistent with our belief that it will be difficult for managers to pass on any tax increase to investors by changing the basic Two and Twenty economic structure.
• Representative Sander Levin (D-MI), a co-sponsor of the carried interest bill being debated in the House, has indicated that he will introduce legislation that would permit tax-exempt organization to invest directly in hedge funds without incurring "unrelated business income tax," which would eliminate the need to form offshore blocker corporations to make such hedge fund investments.
• Representative Levin also made it clear that hedge fund managers should pay the 2.9%  self-employment or FICA tax on "performance allocations," a structure very similar to carried interests held by private equity managers.  Experts disagree on the revenue impact of these taxes on the Medicare system that such taxes fund.
• Representative Rahm Emanuel (D-IL) stated that he will introduce legislation designed to eliminate the ability of hedge fund managers to defer taxes by setting up offshore entities that receive compensation from hedge funds.

Ove the weekend, we'll post a more thorough discussion of the hedge fund issues encountered by tax-exempt investors, and the JCT report's analysis of those issues.