Paul L. Caron

Thursday, May 27, 2010

WSJ: The Double Tax Whammy on Carried Interest

Lead editorial in today's Wall Street Journal, Congress Gets Mean: The Democratic Tax Bill's Double Whammy on Carried Interest:

In the 1999 movie "Payback," Mel Gibson plays a small-time hood who ruthlessly takes on the mob to reclaim $70,000. At one point, he casually shoots holes in the luggage and suits of a high-living mobster played by James Coburn, who says, "Man, that's just mean."

That's the attitude Democrats are taking to American capital markets, as they work to impose the most punitive tax rates on investment income in recent American history. We've already reported that tax writers Sander Levin and Max Baucus plan to raise the tax rate on most "carried interest" income from 15% today to roughly 35% next year, and to about 38% in 2013. But it turns out that, like Mel Gibson, they also want to shoot holes in their victims' suits.

In a little-understood provision, the Levin-Baucus bill would impose a new "enterprise value" tax on the sale of part or all of any investment firm that has ever earned even $1 of carried interest income. So instead of paying the capital gains tax rate on the sale of such shares, the owners would have to pay ordinary income tax on the proceeds of the sale. This means that owners in private equity firms or real-estate trusts would be taxed twice at a rate approaching 40%—first at the time the money is earned and again at the time of the asset sale. The combined tax rate would therefore rise well above 50%.

The Democratic justification for this punitive provision seems to be that firms like the Blackstone Group paid lower tax rates than they should have, so now it's payback time. You'd think these firms have been doing something illegal, as opposed to paying tax rates under the 15% rate that Congress itself passed. But now in their scramble to pay for their runaway spending, Democrats want to punish people who played by Congress's rules even if they earned only token amounts of carried interest. ...

The tax increase on carried interest is destructive enough, but the double whammy of imposing the same higher rate on the sale of a private equity firm or real-estate trust is pure vindictiveness. This crowd on Capitol Hill is just mean.

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In Australia too there is a growing call to apply ordinary tax rates on gains made by private equity on sale of assets. It started to gather speed recently after the US based Texas Pacific Group (TPG) was alleged to have made enormous profit on the public float of shares in Myer group. A draft taxation determination (December 2009) intending to tax private equity gains as ordinary income is still to be finalized. May be the imminent passage of ‘The American Jobs and Closing Tax Loopholes Bill’ (H.R. 4213) in the U.S could be the cue for action.

Posted by: Anton Joseph | Jun 1, 2010 11:03:39 PM