Talking Shop Blog

The proposed jobs bill includes a number of tax increases, including higher taxes on hedge fund managers through the so-called “carried interest” provisions.

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

The carried interest proposals were originally targeted at hedge fund managers. But the 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 that income at the higher ordinary income rates and the income would be subject to self employment tax as well.  Combine the two and the effective tax rate is close to 50%. And that’s before state income taxes.  

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.

President Obama has formally submitted his jobs creation bill to Congress.

The bill, entitled the “American Jobs Act”, includes $250 billion in tax incentives and over $450 billion in tax hikes or “revenue raisers”.

Here are some highlights of the proposed legislation:

First-year 100% bonus depreciation would be extended through 2012.

The current 6.2% Social Security tax rate would be cut in half to 3.1% – for both employees and employers for calendar year 2012. The employer reduction would apply up to the first $50 million in wages. 

Employers would receive a new 6.2% tax credit on the first $50 million in increased payroll. This provision would apply to the last quarter of 2011 and calendar year 2012.

On the revenue side, the bill would limit the tax benefit of itemized deductions and tax exclusions to 28%.  This would apply to married couples with adjusted gross income over $250,000 and individuals with adjusted gross income over $200,000.

This provision amounts to a tax increase for taxpayers in the 33% and 35% tax bracket.

It’s noteworthy that the proposed tax cuts would be temporary – but the proposed tax hikes would be permanent.

Hmmm.

More tomorrow.