Senate tax idea favours long-term carry

The latest twist in the Capitol Hill carried interest drama would treat 65% of carry as ordinary income, but that would drop to 55% for investments held seven years or more.

US Senator Max Baucus, the Democratic chairman of the Senate Finance Committee, today proposed an amendment that would decrease the percentage of carried interest characterised as ordinary income to 65 percent from the a House of Representatives proposal of 75 percent.

The new proposal, if enacted, would still mean that only 35 percent of carried interest would continue to be taxed as capital gains, which enjoys a low 15 percent tax rate. Ordinary income in the US is taxed as high as a 39 percent rate.

However, the Senate proposal seems designed to encourage long-term holds. The amendment decreases the amount of carried interest that is characterised as ordinary income to 55 percent for the sale of investments held for seven years or more.

Baucus’ amendment would soften the blow the House dealt to the private equity industry last month.

The US House of Representatives on 28 May voted 215-204 in favour of HR 4213, called The American Jobs and Closing Tax Loopholes Act of 2010. That bill raised eyebrows because it for the first time proposed a hybrid treatment of carry, with 75 percent characterised as ordinary income and 25 percent as capital gains.

Currently, all carried interest is taxed at the capital gains rate of 15 percent, although that rate is going up to 20 percent when the tax cuts enacted by former President George W. Bush expire next year.

Private equity lobbyists have stepped up efforts to reach members of the Senate since last month’s House vote.

According to a study released today by the industry advocacy group, the Private Equity Council, the impact of an increase in carried interest tax would be swift and broadly felt across the private equity market.

The US House bill could reduce private equity investment by between $7.7 billion and $27 billion per year, according to PEC estimates.

A one percentage point increase in the tax rate is associated with a $1.8 billion decrease in annual private equity investment.

The study estimated that a one-percentage point increase in the tax rate is associated with a 1.07 percent decrease in annual private equity investments. Based on 2009 investment levels, this would translate to a $525 million reduction in investment for every one percentage point increase in the tax rate.

Baucus’ amendment estimates that the provision would raise $14.453 billion in tax revenue over 10 years. If enacted the new tax rates would apply beginning 12 December 2012.