House Passes Carried Interest Tax Change

The U.S. House of Reps today passed a bill that would raise the taxes paid by private equity professionals. Not surprisingly, private equity pros are displeased. As one buyout pro told me this afternoon: “I hated politicians this morning, and I hate them more this afternoon.”

The bill’s primary goal is to address the 26 million Americans caught up in the alternative minimum tax (AMT), which was originally designed to only affect the wealthy. In order to pay for the relief, Congress is proposing that carried interest (i.e., private equity investment profits) get treated as ordinary income rather than as capital gains. That could increase the taxes paid by PE pros — including buyout investors, venture capitalists, real estate partnerships, etc. — from 15% to around 54 percent.

Regular readers know that I support this change, since I consider carried interest to be a fee for services (we can revisit that argument soon). That said, today’s legislation is more for show than anything else. The current bill faces a tough challenge in the Senate, and then the promise of a presidential veto.

In a statement, the White House said: “The administration does not believe that the appropriate way to protect the 26 million Americans from higher 2008 AMT liability — including 22 million that would be newly exposed to the AMT — is to impose a tax increase on other taxpayers.”

So why are Charlie Rangel et. all going through the charade? My theory is twofold: (1) Carried interest is going to become a bargaining chip this year. Everyone acknowledges that AMT must be dealt with, so Rangel has preemptively created a sacrificial lamb. (2) There is now a legislative framework in place for 2009, when it’s expected that Democrats will have a few more Senators and a President Obama. With that, this change passes like taxis on a freeway.

One final note: This is another example of where the vast majority of PE firms could use official representation on Capitol Hill. More than $1 trillion in assets under management, and just a sliver has paid lobbyists. That’s just bad business.