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Investor Groups Line Up to Oppose Tax Increase on Carried Interests

Investor Groups Line Up to Oppose Tax Increase on Carried Interests, Frazier & Deeter

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Since 2016, President Trump has indicated his support for reforming the taxation of carried interests, eliminating what some policymakers call a “loophole” — the taxation of a portion of compensation for private equity and hedge fund managers at the lower capital gains rate of 20% rather than the higher ordinary income rate of 37%. This change is backed by the President and some conservative members of Congress, as it could potentially generate $13 billion in revenue to support other tax breaks and would change distributional effects of tax legislation away from high-wealth taxpayers.

Carried Interest Tax Reform: Background and Recent Efforts

The Tax Cuts and Jobs Act (TCJA) was a first step. It extended the holding period for carried interests to get capital gains treatment to 3 years. Since then, there have been numerous proposals to again cut back on the carried interest benefit, including:

  • Tax part of a carried interest as ordinary income and part as capital gain.
  • Extend the 3-year holding period to 5 years.
  • Treat the grant of carried interests as a loan, with an interest component taxed as ordinary income.

In this Congress, one Democratic House bill, the Carried Interest Fairness Act (H.R. 1091), would tax all carried interests as ordinary income, completely ending the benefit. Interestingly, President Trump’s Press Secretary, Karoline Leavitt, indicated in a press conference in February that the President supports all out elimination of the special capital gains rate, the same thing this bill would do.

Industry Groups Opposed

The major private investment industry groups are strongly opposed to any further change to the taxation of carried interests. National Venture Capital Association (NVCA) President and CEO Bobby Franklin issued the following statement on President Trump’s proposal:

“Carried interest encourages smart, high-risk investments in innovative high-growth startups. The 2017 Trump tax legislation kept venture investment flowing to emerging technologies like AI, crypto, life sciences, and national defense. A change now will disrupt that progress and disproportionately harm small investors, especially in middle America.”

A coalition of 18 free market groups, led by Americans for Tax Reform, released a letter opposing any tax increase on private investment. The group argues that the tax treatment of carried interest is not a “loophole” as “some have long mischaracterized.” Rather, the letter contends it is “an intentional, pro-growth feature of the tax code for more than 100 years that incentivizes risk-taking and entrepreneurship, benefiting investors, public pension funds and retirees.”

The letter points to a 2021 study by John Manuel Barrios, Yale School of Management and Yael V. Hochberg, Rice University, Fellow and Research Associate, respectively, of the National Bureau of Economic Research (NBER) that suggests changing the taxation regime for carried interest would “significantly reduce the attractiveness of forming a new fund for the vast majority of funds in US states other than CA, MA and NY.”  In other words, the change would curtail smaller venture capital funds around the country outside of the main hubs.

What’s Next for Carried Interest Taxation?

Considering President Trump’s full support for eliminating the carried interest capital gains benefit and the loss of the provision’s number one champion in the Senate, former Senator Kyrsten Sinema (I-AZ), who decided not to run again, the provision is definitely on the table. It is therefore likely that some change will be made to carried interests. A longer holding period or partial ordinary income taxation could be the compromise position when the TCJA extension is negotiated. 

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