US Senate Democrats are preparing legislation that they promise will “close the carried interest loophole.”
Earlier drafts of President Biden’s Build Back Better legislation had language that would require private equity managers to hold assets for at least five years before they could qualify for a break on their carried interest taxes. If passed, the measure would raise $14 billion for the Treasury.
The National Venture Capital Association has long opposed taxing carried interest as ordinary income. Last year, the NVCA reported that new research had found that “taxing carried interest as ordinary income would make starting a new fund less economical and instead make steady employment at incumbent companies by comparison far more attractive than forming or participating in venture capital.”
The Build Back Better bill had been on its sick bed for nearly a year when US senator Joe Manchin — one of two Democratic holdouts — announced on Wednesday that he and Senate majority leader Chuck Schumer had worked out a deal.
At the time of writing, fresh drafts of the bill have not been published and the precise details remain unclear. Schumer and Manchin, however, say their newly christened Inflation Reduction Act will inject billions into the American economy through energy, climate and healthcare investments. This will be paid for by, among other things, raising the corporate minimum tax rate to 15 percent and gathering $14 billion from closing the carried interest tax loophole.
“Our tax code should not favor red state or blue state elites with loopholes like SALT [state and local tax] and should focus more on closing unfair loopholes like carried interest,” Manchin said in a statement announcing his new deal. “Through the enforcement of a fair tax code, we can use the revenue to cut the deficit and lower the cost of healthcare for working families and small businesses.”
Schumer has promised a vote on the new bill by next week.
The bill passing is not a sure thing. To avoid the Senate’s filibuster, it must be introduced as part of a reconciliation package with similar legislation from the House. That requires 50 votes. Manchin gives the Democrats 49, while the 50th is Arizona Democrat Kyrsten Sinema. The last time Build Back Better made the rounds, she condemned the carried interest proposals.
Her office had not issued a statement at the time of writing.
Manchin’s about-face is yet another body blow to the private equity industry: private funds suddenly find themselves too close to Washington’s punching radius, with new laws, rulemaking proposals and even prosecutorial priorities aimed at the asset class. Under US Securities and Exchange Commission chairman Gary Gensler, the regulator is considering some of the most radical changes to private fund regulation since the Dodd-Frank era began.
If Republicans win the House in November, they might be able to slow or stop some of the proposed regulations. They could also repeal any legislation they don’t like. Neither are clean bets, though. Among the GOP’s top targets are ESG regulations, as affiliate title Regulatory Compliance Watch reported earlier this month (registration required).
In a Private Equity International survey of 90 fund managers and lawyers last year, 81 percent of respondents said taxing carried interest as income would negatively affect their firm’s operations. When it came to LP alignment, nearly 70 percent said a higher rate would result in significantly less or somewhat less alignment with their investors.
Managers also expressed concern over the attractiveness of the industry. Of the respondents, 43 percent said it would significantly hurt the profession if carry is taxed higher, and a further 36 percent said it would somewhat hurt its appeal.
“The industry becomes less attractive to people, and that has an impact on who does it and who stays in it,” said a London-based fund of funds manager at the time. “I just don’t believe any change to carried interest tax does not have an impact on the industry.”
– Alex Lynn contributed to this report