Democrats Propose New Tax Rate on Investment Funds

By David Cho
Washington Post Staff Writer
June 22, 2007; 5:01 p.m. ET

Top House Democrats today introduced wide-ranging legislation that would more than double the tax rate that private equity firms, venture capital funds and many hedge funds pay on their gains.

The proposed legislation would cause the most comprehensive change to the capital gains tax law in decades. It was authored by Rep. Sander M. Levin (D-Mich.) and introduced by Rep. Charles B. Rangel (D-N.Y.), chairman of the House Ways and Means Committee, and Rep. Barney Frank (D-Mass.), chairman of the Financial Services Committee.

The bill was introduced on the first day of trading of private equity giant Blackstone. Its IPO was one of the reasons Congress became interested in examining how such firms are taxed.

The IPO became one of the richest in Wall Street history this morning when it began trading about 18 percent above its offering price of $31 per share. Late in the afternoon, the stock was holding onto those gains and was trading just shy of $36 per share.

In a statement, Levin said the proposed legislation "would ensure that investment fund managers who take a share of the funds' profits as compensation for investment management services, known as 'carried interest,' would be taxed at an appropriate ordinary income tax rate."

It said that because of their funds' partnership structure, the managers of private investment partnerships currently are able to receive compensation for these services at the 15 percent capital gains tax rate rather than the ordinary income tax rate of 35 percent.

"Congress must ensure that our tax code is fair," Levin said. "We have to be sure that the lower capital gains tax rate is not being inappropriately substituted for the tax rate on wages and earnings."

He added, "Investment fund employees should not pay a lower rate of tax on their compensation for services than other Americans. These investment managers are being paid to provide a service to their limited partners, and fairness requires they be taxed at the rates applicable to service income just as any other American worker."

The bill would not affect members of partnerships who invest their own money, and fund managers who did so would continue to pay the 15 percent capital gains tax rate on their own profits, Levin said.

"The capital gains rate will continue to apply to the extent that the managers' income represents a reasonable return on capital they have actually invested in the partnership," said the statement issued by Levin's office.

The proposed legislation represents the first comprehensive measure to raise rates on the tax treatment for all hedge funds and buyout firms, which have drawn congressional attention because of billion-dollar paydays for fund managers, Bloomberg news service reported.

Lawmakers are targeting carried interest as part of a broader examination of how hedge funds and buyout firms are taxed. Informal estimates show that taxing carried interest at the same rate as salaries may generate at least $4 billion a year in additional taxes, Bloomberg said.

Unions have increasingly criticized the tax treatment of carried interest as buyout firms acquire more companies, putting jobs at risk, the news service said.

"What we're talking about is making the tax system more fair and equitable and transparent to Americans," said Dan Pedrotty, director of the office of investment at the ALF-CIO, the largest U.S. labor federation.

However, the bill has come under sharp criticism from fund managers and trade groups, Bloomberg reported.

"Congress is just looking for an easy target to shake down and raise some more taxes," said Bill Burnham, managing general partner of Inductive Capital LP, a Menlo Park, Calif., hedge fund.

A separate, narrower bill in the Senate that would force hedge funds and buyout firms that go public, such as Blackstone, to pay taxes at corporate rates as high as 35 percent instead of their current rates as partnerships. Individual partners now pay taxes as low as 15 percent on their share of income.

Staff writer William Branigin contributed to this report.

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