U.S. President Donald Trump’s promise to close the “carried interest” tax break that benefits some of Wall Street’s wealthiest financiers could be defanged if his administration proceeds with an exemption for certain firms.
Treasury Secretary Steven Mnuchin recently hinted at a possible exemption to allow partners of financial firms that “create jobs” to continue taking advantage of the tax break.
Any change is far off as Republican tax reform efforts are moving slowly. But if the carried-interest loophole is closed with an exemption for “job creators,” the likely winners will include private equity and venture capital firms, experts said.
A “framework” of Republican tax goals is set to be released on Wednesday. The plan’s authors are discussing the carried interest tax break, but it is not clear if language on it will be included in the framework, lobbyists said.
Carried interest is a share of an investment fund’s profits – typically about 20 percent beyond the return guaranteed to investors – that goes to the general partners of private equity, venture capital and hedge funds.
Under current law, high-income fund partners pay the long-term capital gains rate of 20 percent on their carried interest income, instead of the 39.6 percent individual tax rate that applies to the ordinary wage income of high earners.
Critics say this tax break is unfair because it lets fund managers pay the low capital gains tax rate on much of their income. Fund managers say they take risks to generate the profits that produce carried interest so they should be allowed to pay the lower tax.
Former Democratic President Barack Obama targeted the carried interest loophole but never closed it. Government estimates show it will cost the federal budget at least $20 billion over the next decade.
Carried interest represents a large portion of many fund managers’ incomes. For years they have employed Washington lobbyists to help defend the tax break.
A Treasury spokesman did not respond to requests to comment on the administration’s plans for carried interest.
Mnuchin’s remarks about job creators are widely seen as directed at private equity, venture capital and real estate funds, six lobbyists and tax experts told Reuters.
‘GETTING AWAY WITH MURDER’
Trump pledged during his populist presidential campaign to close the carried-interest loophole, saying hedge fund managers were “paper pushers” who were “getting away with murder.”
Mnuchin, speaking at an event in Kentucky in August alongside Senate Majority Leader Mitch McConnell, said the Trump administration still planned to “close the loophole for hedge funds.”
“What we are focused on is there are many other types of funds that do create jobs and we want to make sure we don’t discourage investment,” Mnuchin said, according to media reports.
When it comes to carried interest, distinctions among different kinds of funds are important.
Fast-moving hedge funds typically hold assets for short periods. So they normally gain little from the carried-interest loophole, which levies long-term capital gains rates on assets held for at least a year.
Only about a fifth of the tax break’s gains go to hedge funds, estimated University of San Diego School of Law Professor Victor Fleischer.
About half the gains from the tax break go to private equity and venture capital funds, which typically invest with longer-time horizons, often in corporate turn-arounds and start-ups.
Fleischer said it would be an “empty gesture” to close the carried interest loophole, but exempt private equity and other firms. “The real money here is in the big private equity funds,” he said. “It’s a joke to say that they’ve closed the loophole if most of the people who benefit from it continue to use it.”
Delineating clearly which kinds firms should and should not benefit from the tax break would be difficult.
“The first reaction of any self-respecting tax geek is ‘How are you going to draw that line?,’” said Donald Marron, an economist with the Urban Institute, a think tank. “The second response will be ‘How will people … game that line?’”
Dallas, Texas, USA, November 2015 – Close up of US Individual Income Tax form 1040. Photo courtesy of SandraRose/iStock/Getty Images