House Democrats’ plan to limit a favorite tax break for private equity -- but not do away with it entirely as President Joe Biden had proposed -- is more restrictive than it first appeared, according to investment advisers and attorneys who’ve examined the details of the proposal.
The proposal, which is part of a $3.5 trillion tax and spending package that House leaders say could get a vote by Oct. 1, lengthens the time period investment funds must hold assets to five years, from three years, in order to qualify for a tax break known as carried interest.
While that appeared softer than the Biden pitch to kill the benefit -- endorsed by Senate Finance Committee Chairman Ron Wyden -- House Democrats still had penciled in the same revenue-raising estimate. One reason why: their proposal includes a host of other changes, including new parameters about when the five-year holding period starts, restrictions on partners entering and exiting the funds and limits on the longstanding tax break on transferring partnership stakes.
The changes could mean that some investment funds have to hold much longer than five years to qualify for the lower tax rates, depending on how the Treasury Department implements the change, if it gets enacted.
“What looks on its face to be five years could actually be eight years,” said Eric Sloan, a partner at law firm Gibson, Dunn & Crutcher who advises private equity firms. “That is a big deal.”
Investment Clock
The clock on the investment holding period doesn’t begin until a fund has invested “substantially all” of its committed capital -- a period that can take anywhere from two to four years for many private equity funds.
Failing to hold investments for long enough to qualify for preferential rates under carried interest can mean much higher tax rates. Under current law, fund managers can pay long-term capital gains rates of 20% on their proceeds if they meet all the carried interest requirements in the tax code, as opposed to the income-tax rate; the top marginal rate is currently 37%.
The House bill has proposed to raise the capital gains rate to 25% and the top income rate to 39.6% -- leaving in place the incentive to qualify for the lower rate.
While critics of the tax break want it eliminated in part as a measure of fairness, proponents say it encourages long-term investment.
Industry Opposition
“This new bill includes specific provisions that will discourage investment, threaten jobs and weaken retirees’ pensions,” Drew Maloney, who leads the private-equity trade group American Investment Council, said in a statement. “Instead of pushing a 98% tax increase on private investment, Washington should encourage more private capital on Main Streets across America.”