Last week, Congress showed it still had a few surprises up its sleeve for the current session.
In a shocking twist, Senate Majority Leader Chuck Schumer and Senator Joe Manchin announced they had reached an agreement on the Inflation Reduction Act, a scaled-down version of Build the best plan again that would address everything from health care to the environment, specifically, higher taxes on corporations. To help pay for all this, the deal included taxing some “carried interest” earnings from partners in private equity and hedge funds, as well as venture capital firms.
Closing this gap would have had a significant impact on the private equity market. But on Thursday, Democrats agreed to waive that provision to gain the necessary support from Sen. Krysten Sinema for the bill to pass the Senate. Here’s everything you need to know about compound interest.
What is carried interest?
Carried interest is a portion of the earnings from a private equity, venture capital or hedge fund that is paid to the fund’s investment manager as an incentive. Basically, it is a reward for the improved performance of a fund or portfolio.
What is the carried interest gap?
While there is nothing wrong with incentives, what has long concerned people about carried interest is how they are taxed. Fund managers who receive carried interest (who tend to be among the wealthiest people in the country) get a tax break on that income.
The loophole treats the income as capital gains, so it is taxed at a maximum rate of 20%, rather than the top tax rate of 37%. This is especially evident for executives like Blackstone Group CEO Stephen A. Schwarzman, who is said to earned $610 million in 2020, but was entitled to pay taxes at a similar rate as the average American. (Blackstone has historically declined to discuss Schwarzman’s tax rate, telling him New York Times last year that its top executives “are among the largest individual taxpayers in the country.”)
In a typical way, says Law360the funds’ general partners earn a 2% fee and a 20% profit share, while limited partners receive 80% of the profits.
The deal struck by Manchin would require carried interest to be taxed at a higher rate, which supporters said could raise $15 billion over the next 10 years.
Why has it stalled so long?
The void of the committed interest was a target of many presidents. Obama vowed to repeal it, but failed. Donald Trump did the same, but was unsuccessful. This is largely because the private equity industry has spent hundreds of millions of dollars on congressional campaigns. Over the past decade, private equity firms and their lobbyists have given almost $600 million in campaign donationsaccording toit New York Times. This buys a lot of favors.
How would closing the loophole affect private equity firms?
A survey of 90 fund managers and lawyers from Private Equity International in 2021 asked what closing the private equity gap would mean. About 81% of those who responded said yes negative impact their operations.
One of the main concerns was that it could become less attractive to job candidates (or those currently in the field), with 43% saying it would significantly harm the profession. Proponents of the loophole also say that removing it could reduce the chances of new investment funds being created.
Private equity lobby groups have been outspoken. American Investment Council wrote in a tweet that “The economy just contracted for the second quarter in a row — Washington should not move forward with a new tax on private equity that supports small businesses, jobs and pensions across America.”
What will replace the carried interest gap?
The new bill could now include a 1% tax on corporate stock purchases.
When will the Senate vote on the bill?
Schumer says he hopes to vote on the bill by Saturday.
This article was originally published on July 28, 2022. It was updated on August 5, 2022 with information about the Democrats’ deal with Sinema.