Dems Aim to Tax Fund Business

Jeff  Carter
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Posted: Sep 16, 2011 12:01 AM

I don’t run a hedge fund, but for those of you that do, this will be of interest. If you run a Private Equity, or Venture Capital fund, this bill will affect you too.

I know several tax specialists with Big 4 Accounting firms from Chicago.

Personally, I think they ought to make it simple. Tax everyone at 15%….or if you want to take the current tax code and apply it, tax the salary that a fund manager draws from managing the fund at the highest rate. Tax the gains from the fund at capital gains. They aren’t taking risk with the salary. No matter what happens, they get their 2%. But the 20% on the back end is where they make their money.

I know several tax specialists with Big 4 Accounting firms from Chicago. Here is what they told me. I have not uploaded the documents they refer to, so ignore that. However, the bullet points are meaningful. Of course, because it’s tax policy, it’s not simple….

Here is what a bunch of them have said.

There is a “wish list” for House Democrats in the context of the Joint Select Committee on Deficit Reduction, which was created as part of the Budget Control Act of 2011. Note the inclusion of taxation of carried interests on the list and in the description. The description is fairly short, but it does indicate an intent to deal favorably with the “enterprise value” issue that is so important to the fund sponsors who have engaged in, or may engage in, going public transactions or who otherwise may consider selling their operations.

The third document is statutory language released tonight by the Obama Administration as part of legislation that would be proposed under the title of the “American Jobs Act of 2011.” The statutory language contains some significant modifications to what we saw moving through the House and Senate in 2007-2010. Given that this is being proposed by the Administration, it is unclear to what extent these changes would be acceptable to members of Congress (Democratic or Republican).

Some of the changes from prior versions of the legislation are as follows:

1. The proposed legislation does not provide for a “blended rate” and appears to provide no relief with respect to enterprise value.

2. The proposed legislation would only be effective for taxable years ending after December 31, 2012.

3. The proposed legislation only recharacterizes capital gains and capital losses as ordinary income and ordinary losses. Capital losses attributable to an investment services partnership interest (“ISPI”) are recharacterized as ordinary losses only to the extent that capital gain was previously recharacterized as ordinary income. The proposed legislation does not defer partnership losses as prior versions did.

4. The proposed legislation continues, in general, to turn off nonrecognition treatment on transfers of ISPIs, but it provides exceptions for certain transfers to charities and transfers to a person with respect to whom the interest also would be treated as an ISPI.

5. The mechanics of the rule relating to distributions of property to an ISPI holder are modified.

6. Consistent with the Administration’s Budget Proposal from earlier this year, the definition of an ISPI is more limited so that it only applies where the interest is in a partnership that is an “investment partnership.” For these purposes, an “investment partnership” means a partnership if, at the end of any calendar quarter ending after December 31, 2012, (1) substantially all of the assets are “specified assets” (i.e., investment assets described in the legislation) and (2) more than half of the contributed capital is attributable to contributions of property by persons who hold their interests for the production of income. It appears that the addition of the “investment partnership” qualifier is intended to more carefully target the legislation to investment partnerships, based on the thought that investment assets and passive capital are hallmarks of an investment partnership. This would seem to provide some relief to the corporate joint ventures. (As an aside, it is interesting that this proposed legislation denies the dividends paid deduction for dividend income allocated to a corporate partner who holds an ISPI. This provision has not been in prior versions of the legislation.)

7. The proposed legislation also applies only where a person holds a partnership interest in connection with the conduct of a “trade or business” that “primarily involves” the performance of services with respect to specified assets. Prior versions required only that the partner provide “a substantial quantity” of such services, and there was no requirement that the activity constitute a trade or business.

8. The rules relating to “qualified capital” and “disqualified interests” are largely unchanged, except that the “investment partnership” limitation that applies to an ISPI is incorporated into the disqualified interest definition.

9. Although the proposed legislation, in general, only recharacterizes capital gain and capital loss, the recharacterization applies more broadly to ordinary income and capital gain for purposes of determining non-qualifying publicly-traded partnership income (after the 10-year grandfather) and income subject to the self-employment tax (although recharacterization for both purposes still is subject to the exclusion for income attributable to qualified capital).

There are a number of more specific technical changes contained in the proposed legislation.


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