Talking Shop Blog

The proposed “tax extenders” bill (Senate Bill 3793) includes a number of tax increases, including the so-called “carried interest” provisions.

A carried interest is an interest in a partnership received in exchange for services to the partnership.

The original carried interest proposals were targeted at hedge fund managers. But the current proposed legislation extends the provisions to profits interests in real estate and other types of investments.

Fund managers in hedge funds and private equity funds typically receive a 20% interest in the profits of the fund in exchange for managing the fund.

Say a fund has $100,000 in long term capital gains for the year. The manager’s 20% share, $20,000, is currently taxed at the 15% capital gain rate. 

The bill, if enacted, would tax 75% of that income at the higher ordinary income rates (50% for certain investments held 5 years or longer).

The bill would also tax profit on the sale of an interest in the partnership as ordinary income, not capital gain (the 75% and 50% rules would also apply).

Maybe there’s a good argument for taxing a fund manager’s profits this way. Maybe not.

But we’ve got a problem with extending these provisions to rental and investment real estate ventures.

It’s common for a general partner to acquire a profits interest when putting together a real estate deal.

The general partner/developer is the one who takes the entrepreneurial risks associated with real estate ventures.

And the reward is a share in the potential “upside” of the deal.

Congress should treat “entrepreneurial capital” the same as other forms of “capital”, like money and property.

And that means capital gains rates, not ordinary income rates.

Congress is scheduled to return the week of November 15 for the lame duck session.

The expiration of the so-called “Bush tax cuts” will likely be the top item on the tax agenda.

Most pundits expect Congress to extend at least some of the current tax rates. The big question is what the rates will be for those with incomes over $250,000.

Congress will also take up the “tax extenders” bill after the election.

The extenders are now contained in the “Jobs Creation and Tax Cuts Act of 2010” (Senate Bill 3793).

The proposed legislation includes the usual extenders, including the R & D tax credit, tax free distributions from IRAs for charitable purposes and the itemized deduction for general sales taxes, to name a few.

You can find a summary of the proposals at http://finance.senate.gov/newsroom/chairman/release/?id=17f14745-0d33-4cac-9c0a-504e632e39b7

Just click on the tab “Summary of the Baucus Jobs Creation and Tax Cuts Act” in the upper right part of the screen. 

How Congress plans to pay for the tax extenders is another matter.

More on that tomorrow.

The Small Business Jobs Act has a section titled “Promoting Retirement Preparation”.

Included here is the provision that allows individuals to make a taxable rollover of elective 401(k) deferrals to a Roth-designated account.  

In general, earnings from a Roth account can be distributed income tax free if certain requirements are met.

And a “Roth conversion” can yield substantial long term tax savings in the right circumstances. Yet the Promoting Retirement Preparation provisions are contained in the “revenue raisers” section of the Act.

So by lowering your own taxes Congress is raising tax revenue? What gives?

It’s simple. Congress thinks short term – one bill at a time.

Even though this provision will produce lower tax revenues in later years, it raises revenue now.

And there’s no net revenue gain to the government over time – it’s actually a net revenue loss.

It’s another example of the budget gimmicks that our legislators use all the time.

You can read more about the new Roth 401(k) rules at

http://blogs.duganlopatka.com/general/2010/09/28/more-on-the-small-business-jobs-bill/

Rahm Emanuel shook hands with commuters yesterday on the first day of his run for mayor. 

Some commentators expect a residency challenge, since Emanuel left Chicago in January, 2009 for his White House position. The Illinois municipal election laws require that a candidate be a legal resident for one year prior to the election.

Potential candidates generally qualify if they maintain a local residence and voter registration. Emanuel rented out his house when he left for D.C. but he apparently maintained his Illinois voter registration.

Election laws aren’t the same as tax laws when it comes to residency issues. But one common denominator appears to be intent.   

Did Emanuel intend to maintain his status as a Chicago resident during his D.C. tenure?

If he filed a 2009 “full year resident” Illinois return maybe he intended to retain his Illinois and Chicago residency. But if he filed a “part year return” or “non-resident” return, that suggests he changed his residency.

Of course Emanuel could have been motivated to file an Illinois residence return for tax reasons.

Illinois has a low 3% income tax rate, while D. C. has a top rate of 8.5%. We’re not sure where Emanuel lived, but Maryland has a top rate of 6.25% and Virginia has a top rate of 5.75%.

If Emanuel listened to his tax advisors, he probably filed as an Illinois resident to reduce his tax bill.   

Of course, that doesn’t really answer the question of whether Emanuel intended to maintain his Illinois residency. It just means he wanted to lower his taxes.