Investment Partnership Carried Interest Targeted Again – Can it Survive?

President Obama Proposes Taxing Carried Interest as Ordinary Income

Since 2007 numerous proposals circulated around congress which attempted to tax investment partnerships performance fee (or “carried interest”) as ordinary income. Strongly opposed by the industry, nothing ever became of the carried interest proposals as they were continually rejected then swept under the rug. On September 12, 2011 President Obama resurrected the proposal by announcing a $467 billion tax revenue bill which includes proposed changes to the tax treatment of carried interest as ordinary income.

Proposed Changes
Currently, carried interest is taxed at a capital gains rate of 15 percent for long term capital gains and qualified dividends which is far below the 35 percent top rate on ordinary income. Because the carried interest from an investment partnership is derived from the performance of services, the proposal would not only tax the managers carried interest at top ordinary rates, but would also subject the income to self employment tax. It is estimated that approximately $18 billion of tax revenue will be generated by increasing the tax rate on carried interest to ordinary rates.

Time to Panic?
The proposal affects a wide spectrum of players in the investment partnership industry which include hedge fund, private equity and real estate managers. As mentioned before, this proposed change is not a new concept. Only time will tell if the interested parties aided with strong lobby presence can once again make this proposed bill disappear or lessen the impact with a modified proposal. If enacted, the proposal would be effective for taxable years beginning after December 31, 2012.