Members of the House Ways and Means Committee and House Financial Services Committee proposed legislation on June 25th that would require investment fund managers to pay tax at ordinary income tax rates on income received from the funds that they manage. Typically, investment fund managers earn a considerable portion of their compensation for the management of a fund in the form of a share of the fund’s profits, otherwise known as a “carried interest.” Under current law, if a fund’s profits are attributable to capital gains income, the manager’s “carried interest” also would be taxed as capital gains and, therefore, at the reduced capital gains rates.

The proposed bill would require that income derived from a partnership as compensation for investment management services be treated as ordinary income received for the performance of services, regardless of whether the carried interest is attributable to capital gains earned by the fund. Managers would still pay the lower capital gains rate on the portion of the managers’ income that represents a proportionate return on the capital they actually invest in the fund.

The proposed legislation provides that investment fund managers would be required to pay ordinary income tax rates on income derived directly or indirectly from any of the following: (i) advising the partnership as to the value of any specified asset; (ii) advising the partnership as to the advisability of investing in, purchasing, or selling any specified asset; (iii) managing, acquiring, or disposing of any specified asset; (iv) arranging financing with respect to acquiring specified assets; or (v) any activity provided in support of any these services. For purposes of the new legislation, “specified assets” would include securities, real estate, commodities, or options or derivative contracts with respect to securities, real estate, or commodities.

The new legislation is the latest attempt by lawmakers to actively regulate investment funds and respond to increased concern over the income realized by managers at top hedge funds and private equity funds. This bill expands upon recent legislation which seeks to tax publicly-traded partnerships as corporations but has much broader implications because it would apply to all partnerships.

The proposed bill, which does not specify an effective date, will be the subject of a Ways and Means Committee hearing in mid-July.