Carried Interest Taxation

Senator Schumer (D-NY) has joined Senator Majority Leader Reid (D-NV) in criticizing the approach of applying higher tax rates only to private equity carried interest.  Senator Schumer would like for the Blackstone Bill to apply to other types of publicly traded partnerships.  Some people have speculated that this approach is an attempt to kill the legislation entirely by broadening the opposition base.  Senator Schumer in fact has shown a fair amount of antipathy in the past, so the speculation might have a note of truth. 

You might ask yourself "what does alternative minimum tax have to do with the debate on carried interests?"  The two topics might be tied, because it is clear that some lawmakers view raising the tax rate on carried interests to be a politically acceptable revenue offset for the cost of a permanent fix to the alternative minimum tax.  This link becomes stronger if Congress is unable to raise the top rate on high income taxpayers back to 39.6%, which inability seems likely in the current administration. 

Senate Finance Committee Chairman Baucus (D-MT) said yesterday that he expected to introduce a more comprehensive carried interest bill later this year.  In general terms, Senator Baucus indicated that he expected the legislation to take a similar approach to the House Bill introduced last month to tax gains allocable to a carried interest as compensation for services regardless of the character of the gain to the partnership.

In the next few days, we're also going to look at two other approaches that have been suggested to address the carried interest issue, (1) taxing profits allocable to carried interest at a rate between capital gain and ordinary income and (2) abolition of the preferential rates for capital gains.

Senate Majority Leader Harry Reid (D-NV) declared today that the earliest that the full Senate would take up carried interest legislation would be 2008.  Senator Reid expressed hesitancy in singling out private equity partnerships for special tax treatment of carried interests.  However, he hinted at supporting expanding the proposal to include oil and gas, real estate and other similarly situated partnerships.

Senator Reid's statement contains good and bad news for both proponents and opponents of carried interest tax legislation.  While it does not appear that Congress will pass legislation this year, the issue is far from dead.  Moreover, while Senator Reid, like Senator Schumer, doesn't want extend the legislation merely to one type of financial partnership, they are actively considering sweeping other types of partnerships into the debate.

John M. Berry, a columnist for Bloomberg.com, has picked up on the calls by the CBO for Congress to examine eliminating the preferential tax rate on long-term capital gains.  You might recall that NYT columnist Paul Krugman proposed a similar answer to the carried interest debate last week.    We will continue to monitor this issue to see if it resonates with lawmakers.  Of course, any such proposal would greatly dwarf the current legislation aimed only at private equity carried interests.