Private equity’s most lucrative tax break is in peril once more.
Included in President Joe Biden’s plan to fund an ambitious expansion in social spending, released Wednesday, is a call on Congress to abolish the preferential treatment given to a key method of compensation for private equity managers.
In addition to salaries, those managers rely especially on a share of the appreciation in the assets they oversee—known as carried interest. Those profits—sometimes in the millions of dollars—have been taxed as capital gains, at a rate much lower than the top marginal income tax rate applied to wages.
Lawmakers have long battled over the benefit’s validity, and Congress will ultimately be the arbiter of the latest proposal. Biden’s plan would not only raise the top rate on capital gains for the wealthiest, but do away with the tax break altogether.
“Permanently eliminating carried interest is an important structural change that is necessary to ensure that we have a tax code that treats all workers fairly,” the White House said in a fact sheet on the plan. The aim is to ensure fund managers “pay ordinary income rates on their income just like every other worker,” the document said.
Looming Fight
Biden’s proposal is one component of a $1.8 trillion, 10-year spending program that would be funded in part with tax increases on individuals.
The private equity industry has successfully fought for years to keep the tax break, and it’s unclear what the final legislation will look like as negotiations proceed in Congress.
Managers are compensated in two main ways: Annual management fees from investors are taxed as ordinary income, but on top of that, managers typically take a 20% cut of the profit on deals when realized, which—because investments are held for a longer period of time—is taxed at the lower capital gains rate.
The current capital-gains rate is 20%, while the top marginal income tax rate is 37%. Biden aims to boost the top income rate to 39.6%, with that same level applied to capital gains for households earning over $1 million.
Playing Defense
The most recent attempt to address what critics call the loophole of carried interest was under President Donald Trump. In 2017, the Republican tax reform fell short of doing away with the benefit altogether, leaving it intact for investments that are held for at least three years—a big win for the industry.
Critics have argued that carried interest is just like any other fee and should be treated that way. Proponents say it encourages long-term investment.