The taxation of carried interests is a common topic of discussion and something that is watched closely by private equity fund managers who derive substantial income from these interests. As background, private equity fund managers derive much of their income from management fees and carried interests. While management fees are taxed at ordinary income rates, payments made in respect of carried interests are currently taxed at the much lower capital gains rate of 20%, thereby allowing fund managers to receive a more favorable tax rate on a substantial portion of their earnings.
While taxation of carried interests is subject to ongoing debate, the issue is frequently highlighted during an election season. In September 2015, Congress’s joint committee on taxation estimated that tax revenue would increase by as much as $15 billion between 2016 and 2025 if carried interests were taxed at the current highest ordinary income tax rate (39.6%) (click here for the report). One view argues that in fairness, carried interests should not be taxed differently from other wage and salary income. The contrary view argues that taxation of carried interests should reward the sweat equity and risk investment managers take when making alternative investments. Below are the top five candidates’ views on the taxation of carried interests.
- Clinton proposes taxing carried interests as ordinary income. She has criticized private equity and hedge fund managers in the past for paying lower tax rates.
- Sanders plans to create four new tax brackets for ordinary income, the highest being 52% on income of $10 million and above. He proposes taxing carried interests as ordinary income to pay for a youth job program that he claims would create 1 million new jobs for young Americans.
- In the past, Trump has criticized hedge fund managers for “paying nothing” in taxes. His plan would tax carried interests as ordinary income, but at the same time, would lower the highest tax rate on ordinary income to 25%. Ultimately, this would increase the carry tax slightly by 1.2% (due to the added 3.8% net investment income tax), but would lower the tax on management fees to 25% from the current ordinary income top rate of 39.6%.
- Cruz would lower the capital gains tax rate to 10% (including carried interests). He also supports a 10% flat tax rate on all ordinary income.
- As a former investment banker at Lehman Brothers, Kasich proposes to lower the tax on carried interests to 15% from the current 20%.