Obama's Budget Seeks to Ensure Hedge Fund Managers Pay 3.8% Tax

  • Provision is among $2.6 trillion in new revenue measures
  • Proposal aims to apply investment tax to certain partners

Inside President Obama's $4.1 Trillion 2017 Budget Plan

Some partners in hedge funds, private-equity firms and other businesses organized as so-called pass-throughs would pay a 3.8 percent income tax under President Barack Obama’s 2017 budget request.

The proposal would extend a “net investment tax” for Medicare that’s been in place since 2013 to taxpayers who’ve been able to avoid it, according to Obama administration officials. The measure, which is projected to raise $271.7 billion over the next decade, would apply to limited partners who “materially participate” in the ventures.

The change is part of a package of revenue proposals that collectively would raise $2.6 trillion from 2017 through 2026, according to the president’s budget request, which was released Tuesday. The revenue it seeks is 67 percent higher than Obama’s 2016 proposal, driven by international tax-reform proposals, changes in the way high-income individuals are taxed and a previously announced fee on oil of $10.25 per barrel.

The budget is expected to face opposition in Congress, where budget committees in the House and Senate have signaled their disregard. They don’t plan to ask Obama’s chief budget architect to make his customary appearance to defend the administration’s plan.

Closing Gap

The plan would extend the 3.8 percent tax to all pass-throughs -- business entities that aren’t subject to corporate taxes but pass their earnings to individual investors or members. The move is intended to address what the administration’s budget documents call “a gap” in legal definitions of investment income and self-employment earnings. As a result, certain members of partnerships, limited liability companies and S corporations may have been able to avoid the tax, according to budget documents.

The proposal would try to close the gap in two ways. First, it would clarify that the tax applies to income received by S corporation shareholders, partners and LLC members who performed services to receive it. Second, it would treat all individual owners of “professional service businesses” as subject to self-employment tax.

Obama also repeated his call for international tax reform; his budget requires various changes, including imposing a 19 percent tax on corporations’ foreign earnings. Under current law, corporations can keep such earnings offshore indefinitely while deferring income taxes on them. In the new budget, the administration says that and other changes would raise $484 billion over 10 years -- more than double the amount projected in last year’s budget.

The budget includes other provisions that Obama has proposed before. A fee of seven basis points on the liabilities of large U.S. financial firms -- roughly the 100 biggest firms, with assets of more than $50 billion -- would raise $111 billion over 10 years. Obama reiterated his call for the Buffett Rule, named for billionaire investor Warren Buffett, which would impose a minimum tax rate of 30 percent, beginning with income levels over $1 million.

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