What would the new interest loophole proposal do?

For years, Democrats and even some Republicans like former President Donald J. Trump have called for the closure of the so-called carry interest loophole that allows wealthy hedge fund managers and private equity executives to pay lower tax rates than entry-level employees.

The agreement reached this week between Senator Chuck Schumer, the majority leader, and Senator Joe Manchin III, a Democrat from West Virginia, will take a small step toward narrowing that special tax treatment. However, it would not eliminate the loophole completely and could allow wealthy business executives to get smaller tax bills than their princes, a criticism leveled by investor Warren Buffett, who has long argued against preferential tax treatment.

The ruling’s fate remains uncertain given the slim majority that Democrats hold in the Senate. They will need all 50 Democrats to support the legislation because Republicans have been united in their opposition to any tax increase. But if the legislation does pass, reducing the charged interest exemption will bring Democrats a little closer to realizing their vision of making tax law more progressive.

What is the benefit?

Carried interest is the percentage of investment gains that a private equity partner or hedge fund manager takes as compensation. In most private equity firms and hedge funds, the share of dividends paid to managers is about 20 percent.

Under current law, this money is taxed at a capital gains rate of 20 percent for those with higher incomes. That’s about half the rate for the top individual income tax bracket, which is 37 percent.

The 2017 tax law passed by Republicans largely left transferred interest treatment as is, after an intense commercial lobbying campaign, but narrowed the exemption by requiring private equity officials to hold their investments for at least three years before reaping preferential tax treatment on their holdings. . interest income.

What will the Mansion Schumer Agreement do?

The agreement between Mr. Manchin and Mr. Schumer would further narrow the exemption, in several ways. It would extend that retention period to five years from three, changing the way the period is calculated in hopes of reducing taxpayers’ ability to manipulate the system and pay a 20 percent lower tax rate.

Senate Democrats say the changes will raise an estimated $14 billion over a decade, by taxing larger incomes at higher individual income tax rates — and lower at the preferential rate.

The longer holding period will only apply to those who earn $400,000 a year or more, in line with President Biden’s pledge not to raise taxes on those who earn less than that amount.

The tax provision mirrors a similar measure that was initially included in the sprawling climate and tax law that Democrats passed in the House last year but that eventually stalled in the Senate. The loaded interest language was removed amid concerns that Senator Kirsten Senema, D-Arizona, who had opposed the measure, would block public legislation. Ms Senema has not yet indicated whether she will agree to any of the new package’s tax provisions. Democrats were essentially betting it wouldn’t block the larger bill on a relatively small change that would raise revenue.

Why is the loophole not closed now?

Many Democrats have tried for years to completely eliminate the tax benefits enjoyed by private equity partners. Democrats have sought to redefine the management fees they receive from partnerships as “gross income,” just like any other type of income, and to treat capital gains from partner investments as ordinary income.

Such a move was included in legislation proposed by House Democrats in 2015. The legislation would also have increased penalties for investors who did not properly apply the proposed changes to their tax returns.

The private equity industry has fiercely resisted, completely rejecting the basic concepts on which the proposed changes were based.

Stephen B. wrote. Klinsky, founder and CEO of private equity firm New Mountain Capital, said in an op-ed published in The New York Times in 2016: “There is no such loophole.” Those levied by New York City and state government were calculated, and his effective tax rate was between 40 and 50 percent.

What will the change mean for private equity?

The private equity industry has defended the tax treatment of transferred interest, arguing that it creates incentives for entrepreneurship, health risk and investment.

The US Investment Board, a lobby group for the private equity industry, called the proposal a blow to small businesses.

“More than 74 percent of private equity investments went to small businesses last year,” said Drew Maloney, CEO of AIC. The private capital that helps local employers survive and grow.”

The Managed Funds Association said changes to the tax code will hurt those who invest on behalf of retirement and college endowment funds.

“Current law recognizes the importance of long-term investing, but this proposal would penalize entrepreneurs in investment partnerships by not giving them the benefit of processing long-term capital gains,” said Brian Corbett, CEO of the association.

“It is critical that Congress avoid proposals that harm the ability of pensions, foundations, and endowments to benefit from the high-value, long-term investments that create opportunity for millions of Americans.”

Jim Tankersley Contribute to the preparation of reports.

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