House Ways and Means Chairman Dave Camp proposes reform to carried interest taxation

Tax and Accounting Center http://taxandaccounting.bna.com/btac/display/batch_print_display.adp 1 of 2 Bloomberg Tax and Accounting BNA Center™ Source: Daily Tax Report: News Archive > 2014 > February > 02/27/2014 > Lead Tax Report > Carried Interest: Camp's Tax Plan Hits Wall Street With Change in Carried Interest Treatment 39 DTR GG-3 Carried Interest Camp's Tax Plan Hits Wall Street With Change in Carried Interest Treatment By Brett Ferguson Investment fund managers would take a hit on their tax bills under House Ways and Means Committee Chairman Dave Camp's (R-Mich.) proposal to dramatically reshape the treatment of carried interest income. Under current law, the share of long-term investment gains that fund managers are allowed to keep for themselves as compensation is treated as capital gains and taxed at about half the rate of ordinary income. President Barack Obama has called for that income, known as carried interest, to be taxed at ordinary income tax rates, saying the payments are more like income from a service performed than a return on investment. Camp, while taking a softer line than the president, says he agrees. “A partnership (e.g., private equity fund) that is in the business of raising capital, investing in other businesses, developing such businesses, and ultimately selling them, is in the trade or business of selling businesses. The businesses bought and sold by the partnership are its inventory,” according to a detailed summary of Camp's proposal. The summary said to apply the tax law consistently, the profits derived by such an investment partnership and paid to its managing partners through management fees and a profits interest in the partnership should be treated as ordinary income. But the Camp proposal also takes into account the technicalities of such businesses, excluding partnerships engaged in the real estate business, and applying a recharacterization formula to partners earning carried interest to take into account any share of invested capital they may own. According to the proposal, an applicable partnership interest would include any interest transferred, directly or indirectly, to a partner in connection with the performance of services by the partner, provided that the partnership is engaged in a trade or business conducted on a regular, continuous and substantial basis consisting of raising or returning capital, identifying, investing in, or disposing of other trades or businesses, and developing such trades or businesses. Recharacterization Formula Applied The recharacterization formula “generally would treat the service partner's applicable share of the invested capital of the partnership as generating ordinary income by multiplying that share by a specified rate of return (the Federal long-term rate plus 10 percentage points), intended to approximate the compensation earned by the service partner for managing the capital of the partnership,” the proposal said. Under the plan, the recharacterization amount would be determined, but not realized, on an annual basis and tracked over time. “To the extent a service partner contributes capital to the partnership, the result would be less capital gain being characterized as ordinary income. Any distribution or gain from the sale of a partnership interest (i.e., a realization event) then would be treated as ordinary to the extent of the partner's recharacterization account balance for the tax year. Amounts in excess of the recharacterization account balance would be capital gain,” the proposal said. 2/27/2014 9:00 AM HOUSE_OVERSIGHT_026543