For years, Democrats have tried -- and failed -- to pass legislation revoking the preferential tax treatment that billionaire financiers can get on a large portion of their compensation.
Now, with populist anger at Wall Street rising during this presidential election season, the "carried interest loophole," which allows the managers of private-equity firms to pay a lower tax rate, is back in the spotlight.
"This year is just different. There has been a populist surge politically in both parties," said Marcus Stanley, policy director for Americans for Financial Reform. "Having the wealthiest people in the financial system paying a lower rate than everyone else is even harder to swallow. People realize that it doesn't have to be like this."
In an USA Today interview last week, presumptive Democratic presidential nominee Hillary Clinton said if Congress didn't act, as president she would ask the Treasury Department to close the loophole. Clinton's approach has been cheered by fellow Democrats and set off grumbles on Wall Street about executive office overreach. But even tax experts say Clinton's approach could be more difficult to accomplish.
The attack on the treatment of carried interest is part of growing anti-Wall Street rhetoric on the presidential campaign trail that has some financial industry officials preparing for a contentious period in Congress. A coalition of labor unions and activist groups launched a new campaign, known as Take on Wall Street, last month to reform the financial industry. Earlier this year, New York State assemblymen introduced legislation to raise taxes on residents who benefit from the tax treatment of carried interest.
At issue is the compensation of the managers of private-equity and venture capital funds. They receive a share of the profits, usually 20 percent, earned on their clients’ investments in exchange for managing those investments. That payment is known as “carried interest.”
Under the current tax code, that carried interest is consider a long-term capital gain, which is taxed at about 20 percent. That’s about half the tax rate these managers would pay if carried interest were treated as ordinary income.
Congress's Joint Committee on Taxation has estimated that changing the treatment of carried interest could raise about $16 billion over the next decade. Academics who have studied the issue say the figure could be much higher, $180 billion.
But any attempt to overturn the status quo would be difficult. Wall Street financiers remain a powerful fundraising source for both Democrats and Republicans. And the industry's advocates note that the treatment of carried interest has been the same for decades and compensates executives who manage investments for years.
"Treasury has recognized for some time that the tax treatment of carried interest cannot be changed through executive action," said James Maloney, spokesman for the American Investment Council, which represents the private-equity industry.
"It would take an act of Congress," he said. "Thus far, Congress has appropriately agreed that carried interest is a long term capital gain. We don't anticipate that changing."
A larger issue may be the Democrats' repeated attempts to overturn the law. By repeatedly failing to change the law, Congress has settled the issue, tax experts say. Changing the policy through an executive order would likely be challenged in court, they said, with lawyers arguing that lawmakers had several opportunities to change the law if they wanted.
“Trying to administratively change the guidance would be a little messy. There is a lot of water under the bridge here," said Lee Sheppard, a contributing editor at Tax Analysts' Tax Notes.
In a statement, the Treasury Department said it "continues to explore its existing authority for ways to address the loophole," but an IRS official recently appeared to concede the point.
"We’re still in limbo because carried interest legislation is introduced with every opportunity,” Clifford Warren, special counsel to the associate chief counsel at the IRS, said June 8 at a Practicing Law Institute seminar in San Francisco, according to Bloomberg. “I think there is a sense we may be treading on congressional territory if we try to go that route.”
Addressing the issue was shelved "because we kept thinking carried interest legislation would get enacted by Congress,” Warren said. “Lo and behold, it still has not materialized, and the proposed regs [regulations] are aging nicely like a fine Gouda on the shelves of our offices.”
Still, that is not likely to close the issue. As Stanley put it: "The notion that Congress makes law by not making law is going to be a tough argument."