Whose investments and of what type.
Why does that matter? I imagine all different types.
who are their clients?
Again why does that matter?
Joe Sixpack? Granny Mae???? You invest(?) in hedge funds?
No. And would it make any difference if I did? If you did or do? If the average small investor did? What's wrong with primarily having rich or even just very rich clients?
A billion dollar bonus taxed at capital gains rates?
1 - Not exactly. a billion is mot the norm (not that I'd have a problem with it if it was the norm) and as for the capital gains rates -
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Myth 2: All Carried Interest Is Taxed at the Capital Gains Rate
In actuality, the tax treatment of carried interest is the same as the tax treatment that the partner would receive if she had received the income directly as an individual. If the fund sells a portfolio company that it has held for more than a year, the resulting profit is long-term capital gain. The partner pays the 20 percent rate on her share of that profit, just as she would if she had sold the portfolio company as an individual. If the fund receives interest income, however, the partner pays the 39.6 percent tax rate on her share of that income, just as she would if she had received interest income as an individual. (The 39.6 percent rate also applies to the fixed fees received by the managers.) The fraction of carried interest on which the partner receives the 20 percent rate therefore depends on how much of the fund’s income takes the form of capital gains and dividends.
Myth 3: Private Equity Funds Receive a Special Tax Break
The tax treatment of carried interest actually follows from partnership tax principles that apply to industries throughout the economy. Internal Revenue Code section 702(b) sets forth the general rule that partners are taxed on partnership income in the same manner “as if such item were realized directly from the source from which realized by the partnership.” If a furniture store partnership, for example, realizes long-term capital gains or dividends, the partners who gain are taxed at the 20 percent rate.
Some critics are troubled by the fact that the carried interest arrangement allocates part of the fund’s capital gains and dividends to the managers when such income “belongs” to the investors who put up the money. It’s not clear, of course, why the gains and dividends don’t belong to the managers, whose labor helped produce this income. In any case, Code section 704(a), a rule that also applies throughout the economy, permits the partnership agreement to allocate different items of partnership income and expense in any desired manner.7 If the furniture store partnership has two partners, one of whom works and the other of whom put up the money, the partnership agreement may allocate any capital gains and dividends received by the store to the working partner and she is then taxed at the 20 percent rate on that income.
The provision in the House bill would not alter the general rule that partners are taxed on partnership income at the same rate as if they had earned the same income directly. Instead, it would carve out an exception to that rule, partially applying the 39.6 percent rate to capital gains and dividends, for only some partners. The affected partners would be those who, at the time they acquired their partnership interest, are reasonably expected to perform “a substantial quantity” of any of the following “investment services”: advising about the value of securities, real estate (held for rental or investment), commodities, partnership interests, and related options and derivatives; advising about the desirability of holding such assets; managing, acquiring, or disposing of such assets; arranging financing to acquire such assets; or activities that support the above services. The provision is clearly intended to target managers at hedge funds, private equity funds, and real estate firms, although it could also affect some other partners. The general partnership rule would continue to apply to all other partners.
Myth 4: The Use of Carried Interest Turns Ordinary Income into Capital Gains
In some ways, this myth goes to the heart of the debate, because it concerns exactly how the tax savings from the use of carried interest arises. The best way to pose the question is: What are the tax implications of the fact that the fund pays carried interest to its managers rather than a salary?8
Consider a fund with one manager, one investor, and $100 of income, all of which is long-term capital gain. Also, assume that the fund simply gives the manager a 20 percent carried interest, ignoring fixed fees and other complicating features of actual compensation arrangements. So, the manager receives $20 of the capital gain and the investor receives the other $80.
Looking at the manager alone, carried interest does appear to turn ordinary income into capital gain. With carried interest, the manager is taxed at 20 percent on $20 of capital gain; if a salary had been paid instead, she would be taxed at 39.6 percent on $20 of wages. (The manager has a $3.92 tax savings). From an overall perspective, though, there cannot be any conversion between ordinary income and capital gain. The fund has $100 of capital gain, neither more nor less, and the only question is how to allocate it between the manager and the investor. So, to get the full picture, we also need to look at the investor. With carried interest, the investor has $80 of capital gain and no ordinary income. If the manager had received a salary instead, the investor would have received the entire $100 of capital gain and would have negative $20 of ordinary income (because the payment of the salary would be an ordinary business expense), which presumably could be used to offset other income.
Although the use of carried interest increases the manager’s capital gain by $20 and reduces her ordinary income by $20, relative to the salary alternative, the arrangement has the opposite effect on the investor. The use of carried interest rather than salary does not convert ordinary income into capital gains and dividends at the aggregate level, but instead reallocates the two types of income between the manager and the investor.
Carried interest is not guaranteed to yield a net tax saving in every instance. If the investor and the manager are both individuals in the top tax bracket, the $3.92 tax savings for the manager are offset by a $3.92 tax increase on the investor. There is no loss to the federal treasury. And, since both the manager and the investor know about the tax effects going in, they can negotiate the terms of their arrangement to cancel out their individual tax effects.
In practice, though, carried interest usually yields a net tax reduction, because the investor is often a tax-exempt organization that pays no tax on either capital gain or ordinary income. In that case, the reallocation of the two types of income is tax-reducing, because there is no offset for the manager’s tax savings. It is unsurprising that the Joint Tax Committee estimates an $18 billion revenue increase from the proposal.
Although carried interest often reduces taxes, the tax reduction is not obtained by “turning” ordinary income into capital gain. Instead, it is obtained by reallocating the two types of income between managers and investors. The key question is whether this reallocation is inappropriate.
As stated above, this type of rearrangement is available to any partnership in the economy under general tax rules. To be sure, there are three reasons the tax savings available to private equity funds are likely to be greater than the tax savings available to other partnerships, such as furniture stores. First, the dollar amounts are larger. Second, capital gains play a much larger role for private equity funds than other partnerships; in a furniture store partnership, most of the income is likely to be ordinary operating income. Third, tax-exempt organizations provide more of the investment in private equity funds.
Before directly tackling the question of whether the tax saving from carried interest is appropriate, one more myth should be addressed.
Myth 5: Carried Interest Is Simply a Means of Tax Avoidance
In reality, carried interest serves important non-tax purposes by giving managers strong incentives to choose the best investments and manage them properly, and helping the firm attract more able managers (who would find this arrangement the most attractive). Fleischer, the most prominent advocate of changing the tax treatment of carried interest, has recognized that carried interest “provides the most powerful incentive to work hard … and is considered essential to attracting talented managers.”9 Carried interest would, therefore, likely be used even if it offered no tax savings; indeed, as the University of Chicago’s David Weisbach has observed, it was used in years when capital gains and ordinary income were taxed at the same rates.10
Of course, because carried interest does usually provide tax savings, tax motivations have probably prompted its increased use to some extent. It also may have attracted more tax-exempt organizations to invest in funds that use this arrangement; if the provision is adopted, the incentive for tax-exempts to take their cash elsewhere may be powerful.
american.com
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If the dems endorsed that
If the Dems endorsed low tax rates as a goal, I'd probably be cheering them on. If they also endorsed reduced spending so that we could have lower taxes with balanced or near balanced budgets I'd definitely chear them on.
They are bandits, thief's
Nonsense, they negotiate a fee for a service and get paid for that service. Anyone who doesn't want to pay a fee doesn't have to do business with them (unlike government who really does take your income by force) |
