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Tax Increase on Buyout, Real Estate Firms Gains in House

House Democrats, who have approved tax increases on managers of private equity funds three times in the past only to see the legislation stall in the Senate, are likely to succeed in their latest effort.

The higher tax on executives at buyout firms such as Blackstone Group LP and KKR & Co., real estate partnerships and venture capital funds is backed by the White House and would be included in a bill covering everything from aid to the jobless to shielding doctors from cuts in Medicare fees, lawmakers say.

The legislation may be completed as early as this week, and lawmakers say they want to pass it before May 31, when health- care subsidies and benefits for the unemployed run out.

“They’re using live ammunition,” said Jeffrey DeBoer, president of the Real Estate Roundtable, which, along with the National Venture Capital Association and Private Equity Council, is trying to stoke Senate opposition to the House plan.

Passage would be a reversal of fortune for the investment partnerships that in 2007 helped quash a plan to target carried interest, or the share of profits paid to fund executives. That share now qualifies for the 15 percent capital gains rate. The new proposal would tax the income as wages, with a top rate of 39.6 percent plus up to 3.8 percent in Medicare taxes.

Senate Finance Committee Chairman Max Baucus said “there is a certain sense of inevitability” that a higher levy on carried interest will be included in a broader bill.

‘Alive and Well’

“Carried interest is very alive and well,” Baucus, a Montana Democrat, said on May 17 of the proposed new tax. He said the details haven’t been decided.

Senate Budget Committee Chairman Kent Conrad said lawmakers are considering the tax increase to help fund a $180 billion measure to renew tax breaks for businesses and extend a program that subsidizes local bond sales, as well as help both the jobless and doctors facing Medicare cuts. The tax would generate about $20 billion, the North Dakota Democrat said.

“There is a growing chance that something with carried interest will be included,” he said.

The partnerships are pushing back and have made some headway. Four Senate Democrats and Massachusetts Republican Scott Brown sought a waiver for venture capital funds from the tax increase. Real estate and venture capital groups are holding meetings on Capitol Hill in an effort to persuade lawmakers that they create jobs and that penalizing fund executives would impede growth in their industries.

‘Low-Hanging Fruit’

Still, the affected industries are concerned they are “the lowest of the low-hanging fruit,” said Marc Heesen, president of the venture capital association.

“Unless they can find other sources of revenues, they’re going to go after carry,” Heesen said.

White House Budget Director Peter Orszag on May 12 predicted the Senate will pass changes to the tax treatment of carried interest “within the next few weeks.” President Barack Obama sought the change in each of his first two budgets.

Executives in investment partnerships are typically paid 2 percent of fund assets as an annual management fee and 20 percent of the profit earned for investors above certain levels. While the management fee is taxed as income, the share of profit -- the carried interest -- is taxed at the lower capital gains rate. The rate is scheduled to rise in 2011 to 20 percent from 15 percent. In 2013, a 3.8 percent Medicare tax will be added for high-earners.

Fee for Services

Democrats such as House Ways and Means Committee Chairman Sander Levin of Michigan say carried interest is a fee for services and should be taxed as wages.

“There’s no reason why people who work for Goldman Sachs should be taxed at one rate and people who work at leveraged buyout firms should be taxed at a different rate,” said Chuck Marr, director of federal tax policy at the Washington-based Center on Budget and Policy Priorities.

Levin’s proposal evolved in 2007 as leveraged buyout firms reported profits that labor groups said came on the backs of employees fired from companies acquired by the firms.

Labor-backed research institutions such as the Economic Policy Institute called it a “loophole for hedge fund managers” even though few hedge funds hold positions long enough to qualify for long-term capital gains rates.

“Policymakers are starting to understand that this is not a hedge fund bill that tangentially affects other businesses,” DeBoer said. “It is a real estate tax increase bill that tangentially affects hedge funds.”

The proposed tax increase passed the House again in June 2008 and last December, each time getting nowhere in the Senate.

The U.S. had 3.1 million partnerships in 2007, according to IRS statistics. Some 1.5 million were real estate partnerships. Finance and insurance partnerships totaled 308,307, of which 8,981 were hedge funds. The rest include industries such as farming and construction.

Doug Lowenstein, president of the Private Equity Council, says increasing taxes will discourage risk-taking.

“The notion that you can raise people’s taxes 180 percent and everything goes along just hunky dory is just naïve,” Lowenstein said.

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net.

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