Obama again takes aim at carried interest

Now that the US Congress has avoided a government shutdown by passing a 2011 budget, attention shifts to the 2012 budget. A carried interest tax hike may be enacted to help pay for spending cuts.

Private equity managers are likely to pay more taxes on carried interest in 2012 to help pay for Republican-initiated spending cuts.

President Barack Obama’s 2012 proposal directs the US Congress to require executives of private equity firms to pay ordinary income tax rates as high as 35 percent (39.6 percent after 2012) on the profits they receive as compensation. Carried interest currently qualifies for lower capital gains tax rates of 15 percent (20 percent after 2012).

Republicans in the House of Representatives want to address the deficit. While carried interest would be a drop in the bucket in terms of plugging deficit holes, Republicans will have a harder time protecting big business, according to a New York-based tax attorney. “Carried interest is going to be less of a priority for House Republicans,” said the attorney. “The spending gap is too great.”

Congress came close to raising the carried interest tax rate last year, but it ultimately stalled in the Senate.

The proposal appears to be a scaled-back version the Senate considered last year, as the president’s previous budget’s proposal on carried interest would have raised $24 billion in tax revenues over 10 years and this one would generate $14.8 billion over the same period.

In December, US Senator Max Baucus, a Democrat, dropped a provision in the contentious tax cut bill that would have more than doubled taxes on carried interest. The Senate bill would have prevented general partners from paying taxes entirely at the capital gains rate on carried interest. Under certain rules, up to 75 percent of carry could have been treated as ordinary income beginning this year.