Baucus Drops Higher Private-Equity Levy From Tax Bill

Senate Finance Committee Chairman Max Baucus
Senate Finance Committee Chairman Max Baucus. Photographer: Chip Somodevilla/Getty Images

Executives at investment partnerships including private-equity firms and hedge funds have won a four-year battle with congressional Democrats over increasing taxes on a large portion of their pay.

U.S. Senate Finance Committee Chairman Max Baucus, a Montana Democrat, omitted a provision to boost tax rates on so-called carried interest from a bill to extend 2001 and 2003 tax cuts for middle-income Americans that is set for a Senate vote tomorrow. The bill also would renew dozens of expired business tax breaks to which the carried interest proposal had been attached as a budget-balancing measure.

The omission closes the door on efforts by Democrats to change the tax treatment of carried interest. Carried interest is the compensatory share of an investment partnership’s profits that fund managers receive as part of their pay. The pay can qualify for the 15 percent capital gains tax treatment even though it’s a return on labor rather than capital invested.

“I think, for all practical purposes, it’s in a deep coma, not to come out until the discussion of tax reform,” said Clint Stretch, managing principal at Deloitte Tax LLP, a Washington consulting firm. “It looks like it’s dead for this year.”

Democrats’ Priority

Since winning control of Congress in 2006, Democrats have made taxing such income at ordinary rates a priority. The House voted in May to tax three-quarters of carried interest as wages. While the Senate trimmed it back to a 50-50 split in June, objections from Republicans and some Democrats blocked the proposal from being considered on the floor.

The Obama administration has proposed taxing carried interest as ordinary income in each of its annual budget proposals.

Barring inclusion of the tax proposal in a deal between the White House and congressional Republicans over extending Bush-era tax cuts set to expire Dec. 31, the omission from Baucus’s bill is a victory for private equity firms such as Blackstone Group LP and KKR & Co. These firms have lobbied against the changes, along with groups including the National Venture Capital Association and the Real Estate Roundtable.

Peter Rose, a spokesman for Blackstone, declined to comment on the proposal.

Republicans, who oppose the tax increase, take control of the House in January, when a new session of Congress begins.

‘Never Say Never’

“Never say never, but the odds are moving more and more in our direction that this Congress will not pass carried interest legislation, which directly impacts venture capital,” said Mark Heesen, president of the National Venture Capital Association.

The proposal may arise again in another session of Congress as lawmakers look for ways to bring the federal budget deficit under control and seek revenue-raising measures.

“There’s always a possibility that something gets resurrected,” said Mike Jackson, managing director in charge of the private wealth practice at LECG Inc., in Devon, Pennsylvania. That’s especially the case with carried interest, he said, because it “affects so few people.”

The Baucus bill would renew a package of dozens of tax breaks that lapsed last year. They include a research-and-experimentation credit used by thousands of companies, including Palo Alto, California-based Hewlett-Packard Co. and Cedar Rapids, Iowa-based Rockwell Collins Inc.

Poison Pill

The carried interest provision has been a poison pill preventing renewal of those measures on a stand-alone basis. In the Senate, about a half-dozen Democrats were united with all Republicans in opposing the changes. As recently as last week, Baucus told reporters that he was having trouble finding enough support for the tax increase.

The Baucus bill also drops a number of changes to international tax laws fought by multinational companies such as International Business Machines Corp. and business such as the U.S. Chamber of Commerce. Objections to those changes in the Senate also were impeding passage of the business tax breaks.

Other major business breaks allow companies such as General Electric Co. to defer U.S. tax on income earned from certain lending overseas.

For individuals, Baucus’s measure would renew popular tax breaks such as a deduction for state and local sales taxes paid. That would add a deduction for residents of states with no income tax, such as Texas, Florida and Washington.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE