US carry tax reform ‘practically difficult’

Doubts over whether plans to tax carry as income will be actionable have been raised, along with suggestions a renewed legislative proposal to do so may fail.

The new US administration may have a tough time mobilizing a plan to tax carried interest as income given the difficulty differentiating private equity limited partnerships from similar arrangements in other sectors, according to an industry expert.

“From a technical perspective, it may be difficult to carve out private equity limited partnerships from other types of limited partnerships, such as family businesses organized as a partnership, energy master limited partnerships, real estate partnerships, etc,” said David Larson, managing director at independent valuer Duff and Phelps. 

“Changes that impact private equity could, in fact, impact all types of partnerships, which may not be desirable by tax policy makers.”

Both presidential candidates vowed to close the so-called carried interest tax loophole – which allows private equity and hedge fund managers, along with 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.

Opponents to the new law say removing the carried interest tax break would not only nearly double the taxes paid by private equity managers, but would also take away an important incentive for investors to risk capital, which is a critical tool for mid-market company growth.

“The facts don’t fit into soundbites. Because of prior tweaks to tax regulations, the amount of tax proceeds that could be generated from re-characterizing private equity capital gains as ordinary income may not be as significant as expected,” Larson said.

General partners widely expect new rules to be pushed through within nine months of the new president taking office, as big changes to financial policy have been made at the start of the past five administrations. But whether this materializes remains to be seen; several legislative proposals to get rid of the carried interest tax rate to-date have failed.