Carried Interest: some senators want venture capitalists to get a CG ride on their compensation income

by Linda Beale
crossposted with Ataxingmatter

Carried Interest: some senators want venture capitalists to get a CG ride on their compensation income

Everybody knows by now that managers of partnerships who have “profit interests” have been claiming that they do not have compensation income but merely a return of capital on their “carried interests” (and that may be long-term capital, they claim, when they hold the profits interest for some time and there are long term gains in the partnership that are allocated to them).

Many tax experts, including myself, have argued that these profits should be taxed as compensation. At ordinary rates, like the janitors and clerks and other employees of the firm. Immediately and without deferral, like others who work for a living. And subject to payroll taxes (FICA, FUTA), since wages are supposed to be subject to payroll taxation.

Managers of private equity, hedge, venture capital, real estate and other partnerships have been able to avoid such real world consequences of working for a living in most part. They are generally paid a fee (usually about 2% of assets under management, in hedge and private equity firms) and a “carried interest” (usually about 20% of assets under management, each year, and sometimes amounting to 30% or 50%, for the really big-time managers). They do treat the fee as compensation, but claim that the carried interest is not.

Congress is finally quite likely to pass a bill that will treat carried interest as the compensation that it is. So of course each type of partnership management is lobbying for an exception for itself–tax the others, but I’m so important that you ought not to tax me because continuing to give me this incredible tax break will keep me doing this really important stuff.

That line is garbage. These managers generally make kaboodles of money. They will still do the work and making kaboodles of money even if they have to pay taxes more like ordinary employees.

But some senators seem to be falling for this crappy argument. For example,Republican Scott Brown of Massachusetts and Senators Patty Murray of Washington, Mark Warner of Virginia, Bob Casey of Pennsylvania and Jeanne Shaheen of New Hampshire want to exempt venture capital firms from the change in the treatment of carried interest. The claim boils down to saying that if you tax these managers on their compensation like you tax “regular” workers, it will hurt the work that these venture capital firms do in encouraging entrepreneurialism. See Donmoyer, Senators Seek Venture Capitalist Waiver from Fund Tax Increase,, May 13, 2010.

Can these senators really think that taxing the worker will make the managers stop managing billions of dollars?

Lobbying is underway. Listen, Congress, to your head and not your pocketbooks. Managers of partnership perform services and get paid for those services. All of that payment should be treated as compensation, be taxed at ordinary rates, and be subject to payroll taxation. To do otherwise is to let very wealthy people off the hook for their share of the tax burden, and to impose a greater tax burden on everybody else–especially on the little people.

Can the voters put two and two together to realize that any senators who end up supporting an exemption for the real estate industry or the venture capital industry (or any other industry) are more worried about losing the support of big money than they are about ensuring that big money managers pay taxes fairly just like so many ordinary American workers do?

And if you are wondering whether firms like hedge funds and private equity funds–significant parts of the “shadow” banking system–add real value to the economy, you might enjoy this article by Harlan Platt about private equity, The Private Equity Myth. Download Platt. The Private Equity Myth.