Q: What is the carried interest loophole and will it ever go away?

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A: The carried interest loophole refers to very favorable tax rates paid by managers of private equity funds (generally not hedge fund managers, who use other strategies to avoid taxes). These investment managers get a cut of any profits their funds earn (usually 20%), called “carried interest,” which originally referred to Renaissance-era ship captains taking a cut from the sale of cargo they “carried.” Carried interest is taxed at the 20% rate for long-term capital gains, rather than as ordinary income, which would likely be at 39.6% for these big-money earners (see the chart above). This means PE managers pay half the taxes they would if this loophole were closed. Who says they want to close the loophole? NYC mayor Bill DeBlasio, NY Senate IDC Leader Jeff Klein, and presidential candidate Trump, among others. Who likes the status quo? The private equity industry! Some have argued it could be ended by presidential directive to the IRS, but it would take an act of Congress to avoid legal challenges. In the meantime, New York State could pass a state tax to offset the loophole, like the one recently passed by the Illinois State Senate. In 2007 and 2010 Chuck Schumer wanted to make sure “New York partnerships are not singled out” and was challenged by Barney Frank who said: “The best way to avoid supporting what is doable is to insist on making it un-doable. Schumer wanted to broaden the bill to death.”

- originally published in the 8/27/2017 newsletter

Stephanie Lee