This morning, Representatives Rangel, Frank, Levin and others introduced legislation in the House that would radically change the taxation of managers of funds holding carried interests. The bill is broader than the legislation proposed by Senators Baucus and Grassley last week aimed at publicly traded private equity firms, and indeed is much broader than most of the speculation in the media and otherwise about the taxation of carried interests.
- The bill would tax income allocated to the holder of an “investment services partnership interest” (which we’ll dub an “ISPI” because the tax world needs one more acronym) as compensation for services, meaning not only ordinary income treatment but presumably the application of self-employment tax to the income.
- The bill would limit the losses deductible by a holder of an ISPI to the income previously allocated with respect to the ISPI. It is unclear how this rule would apply to the holders of ISPIs in more than one partnership.
- The bill would cause the fund to recognize gain if it distributed assets in kind to the holder of an ISPI. It is unclear whether the carried interest holder, the fund investors, or both, are allocated this gain.
- The bill would treat gain or loss from the sale or other disposition of an ISPI as ordinary income or ordinary loss from the performance of services.
- The bill would apply the ISPI rules to characterize the income earned by a REIT in a partnership for purposes of the character of the income that flows through to the REIT’s investors. The rules would not apply to disqualify the REIT’s tax status as a flow-through.
- The definition of an ISPI is an interest in a partnership if the holder directly or indirectly provides certain investment advisory services with respect to securities, real estate, or commodities (or options to acquire such assets). The bill contains rules that would not apply the treatment described above to the portion of the partnership interest attributable to the contribution to capital, subject to a reasonable allocation between the return from the capital contributed and the remaining income allocated.
We are monitoring the debate regarding this issue, including legislative developments. You can follow the developments in real time at www.carriedinteresttaxation.com .