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PE industry braced for imminent carry legislation

Industry players predict closing the carried interest loophole will be an immediate priority for the incoming US president.

Legislation to close the carried interest tax loophole in the US will be passed within nine months of the new president being sworn in, private equity insiders predict.

Delegates at the PEI Private Fund Finance and Compliance Forum in San Francisco on Tuesday agreed action was likely based on current sentiment, and the historical pattern of legislative change post-presidential election.

“Big changes have been made to financial policy at the start of the past five administrations. There is a belief the carried interest issue will be dealt with as a priority,” one general counsel said.

A second participant predicted the matter would be dealt with within the first six to nine months of the incoming presidency.

The Wall Street carried interest tax loophole allows financial managers at private equity firms, hedge funds and other qualifying firms to pay a capital gains tax rate – as low as 23 percent – on their income instead of the higher income tax rate of 39 percent. Both Hillary Clinton and Donald Trump have called for taxing carried interest as ordinary income, ie at the 39 percent rate.

While this may come as a blow to alternative fund managers, delegates agreed that, should legislation on carry be passed, adjacent legislation to address management fee waivers would be put on the backburner.

Last July, the US Internal Revenue Service proposed rules that would make it harder for firms to convert high-taxed fees into lower-taxed carried interest, thereby taking advantage of a tax percentage-point difference of almost 20 percent.

“It’s hard to predict a date for the [management fee waiver] legislation to be passed, but it’s possible that if carried interest was changed, then the management fee waiver legislation might simply go away,” a second general counsel said.

If the legislation concerning management fee waivers is passed, it is widely expected that it won't be backdated. This means any management fee waiver agreements made prior to the issuing of guidance on the matter will be respected.