May 23,2019

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Wyden Bill Ensures Hedge Fund Managers Pay Their Fair Share in Taxes

For the first time, Wyden’s bill closes entire carried interest loophole

Washington, D.C. – Senate Finance Committee Ranking Member Ron Wyden, D-Ore., today introduced legislation to close the carried interest loophole and ensure hedge fund managers and private equity CEOs pay their fair share in taxes.

For the first time, the bill proposes closing the entire carried interest loophole—re-characterization of income from wage-like income to lower-taxed investment income and deferral of tax payments. Previously introduced bills only address half of the problem.

“One of the most indefensible loopholes in the tax code allows wealthy hedge fund managers to be taxed at lower rates than cops and nurses,” Wyden said. “President Trump railed against it on the campaign trial, but he broke his promise when the time came to act. Instead of closing loopholes, he handed corporations and the wealthy hundreds of billions in tax breaks. If President Trump wants to address carried interest and make the tax code more fair, he’ll be happy to support my new proposal that would fully close the loophole—existing bills only address half the problem.”

To prevent the re-characterization of income, fund managers would be required to recognize annual compensation that would be taxed at ordinary income rates and subject to self-employment taxes. Annual compensation would be determined using the estimated forgone interest on an implicit interest-free loan from investors to the fund manager at a prescribed interest rate.

To prevent deferral of tax payments, the bill treats transactions as occurring outside the partnership between fund managers and investors, decoupling compensation from future sales of investments and ensuring the value of the fund manager’s carried interest is taxed from the outset. Under current law, the fund manager’s carried interest is taxed as income from the partnership, which allows the deferral of tax payments until future investment sales.

To account for the re-characterization to wage-like income and avoid double taxation, the fund manager would also realize a long-term capital loss equivalent to the annual compensation, which could offset the fund manager’s future long-term capital gain from sale of an investment. As with all capital losses, the loss could be used to offset long-term capital gains or carried forward.

For example, if the fund manager receives a 20 percent carried interest in exchange for managing investors’ capital of $100 million, and the prescribed interest rate for the tax year is 14 percent, the fund manager would pay the top ordinary income tax rate of 40.8 percent tax on $2.8 million in deemed compensation.

Text of the legislation is available here.

A detailed summary of the legislation is available here.

A one-pager summary of the legislation is available here