Parting with profits

Many industry players were sure the momentum for a carried interest tax increase in the US died last year when a new Republican Congress took control. Not so. US President Barack Obama’s budget proposal puts a tax hike firmly back on the table.

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

While the proposal appears to be a scaled-back version of what the Senate considered last year – 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 – Obama should expect some push-back from the industry as well as House Republicans.

“Republicans are tired of this fight, but here they go again,” says a tax attorney based in New York. “A lot of people thought [Senator Max] Baucus’ failure last year would be the end of the [carried tax] discussion.”

In December, US Senator Max Baucus, a Democrat who is chairman of the powerful Senate Finance Committee, dropped a provision in the contentious tax cut bill that would have more than doubled taxes on carried interest. The Senate bill stipulated up to 75 percent of carry could have been treated as ordinary income beginning this year.

Baucus’ effort ended in December and the private equity community declared victory, having for several years fought against Baucus’ (and other Congress members’) various bills that have proposed the redesignation of carry tax. In 2007, when Congress’ interest in carry tax seemed to reach a pinnacle, one tax expert remarked that the issue was probably the most lobbied tax provision in more than 20 years. That lobbying seemed to have paid off.

But the renewed debate may be tougher to fight in the current political climate. “House Republicans want to address the deficit. And while carried interest would be a drop in the bucket [in terms of plugging deficit holes], Republicans can no longer blindly protect big business,” said a tax attorney. “Private equity is part of it, no doubt. Congressmen are going to pick their battles more carefully. So, Obama has a chance even with a Republican House.”