Paul L. Caron

Monday, May 9, 2016

Taxing Carried Interest As Ordinary Income Through Executive Action

Following up on my previous post, Taxing Carried Interest As Ordinary Income Through Executive Action:  New York Times:  Ending Tax Break for Ultrawealthy May Not Take Act of Congress, by Gretchen Morgenson:

It’s only natural that Barack Obama, entering the homestretch of his presidency, would be concerned about his legacy. Judging from a recent interview in The New York Times Magazine, getting credit for the actions he has taken on economic issues seems to be of special interest to him.

Mr. Obama expressed frustration that many middle-class Americans feel they’ve been left behind during his time in office. The wealthiest Americans, meanwhile, have become richer during the Obama years.

There is a lot about this problem of income inequality — and about the economy over all — that Mr. Obama cannot control. Still, there is something he could do right now to help narrow the widening gulf between rich and poor.

In one deft move, Mr. Obama could instruct officials at his Treasury Department to close the so-called carried interest tax loophole that allows managers of private equity and hedge funds to pay a substantially lower federal tax rate on much of their income.

Forcing these managers to pay ordinary income taxes on the gains they reap in their funds would accomplish two things. It would take away an enormous benefit enjoyed almost exclusively by some of the country’s wealthiest people. And, tax experts say, it would generate billions in revenue to the government each year, though there are wide differences over exactly how much.

But doesn’t changing the carried interest loophole require an act of Congress? Not according to an array of tax experts. Just as Mr. Obama’s Treasury Department recently changed the rules to curb corporate inversions, in which companies shift their official headquarters to another country to lower their tax bills, the Treasury secretary, Jacob J. Lew, and his colleagues could jettison the carried interest loophole.

Alan J. Wilensky is among those urging such a change. He was a deputy assistant Treasury secretary in charge of tax policy in the early 1990s when the carried interest loophole came about. “This is something President Obama can do and should do,” Mr. Wilensky said in an interview. “This is not an impossible thing to get done.” Now a lawyer in Minneapolis, Mr. Wilensky recently wrote an article on this topic for Tax Notes, the definitive publication on national and global tax issues [The True Story About the Taxation of Carried Interest, 150 Tax Notes 1173 (Mar. 7, 2016)].

Victor Fleischer, a law professor at the University of San Diego, is another who has recommended that the Treasury get rid of the unjust tax treatment on carried interest. Mr. Fleischer, a contributor to The New York Times, has also estimated how much money such a change would bring to the Treasury.

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Yawn. This issue is a waste of tax reform bullets. Compared to EITC fraud, carried interest is chump change. The main reason for this noise is to fuel further class warfare.

Posted by: Dale Spradling | May 10, 2016 5:33:27 AM

Look, carried interest is treated as a long term cap gain because the investment on which the manager gets paid is a long term gain or loss. Gretchen Morgenson is no expert n anything. There is no way an EO can override tax law. It does not mean Obama will not try, but the courts would likely stop it.

Posted by: Rick Caird | May 9, 2016 12:40:06 PM

I'll go further and bet that the IRS will grow a spine and reject legal requests by the administration if it is contrary to their desires. Take the 'Cadillac tax" on some heath plans which was created by law and not collected by the IRS due to administration fiat, legally companies still owe the tax and the president could order it collected but the IRS would no doubt refuse to comply with that perfectly legal order.

Posted by: max | May 9, 2016 8:30:34 AM

shouldn't carried interest be treated as a short term capital gain rather than as ordinary income? it would eliminate the preferential rate while allowing a private equity manager to defer the tax until recognition of the gain/sale of the investment. thus the manager wouldn't be taxed on phantom paper gains while holding the investment. seems more fair on both sides

Posted by: john | May 9, 2016 8:30:30 AM

Wow, a former bureaucrat and a professor take a position consistent with the bias of a New York Times reporter. How could any reasonable person disagree?

Posted by: Nathan | May 9, 2016 7:50:30 AM

Given today's expansive limits on legislative action by the Executive Branch, how about forgiveness for the inflationary part of capital gains? No need to change the law. Just tell the IRS not to take any enforcement action against taxpayers who claim an inflationary adjustment to basis. The precedent now exists, and the IRS has shown that it is willing to endorse any extra-legal action the Administration requests.

I'm betting that the IRS will grow a spine on illegal requests by the Administration the day a Republican becomes President.

Posted by: AMTbuff | May 9, 2016 6:38:34 AM