carried interest tax

[kathyc2]

I'm not trying to start a political discussion, but hoping for clarity on carried interest.

I don't have hedge fund managers in my client list, but my understanding is that they can structure their business so that profits are taxes at LTCG rates, which currently can be up to 23.8%. The Trump tax plan says top rate of 15% for business profits, so it looks to me that they would actually be getting a lower rate. Is my reasoning flawed?

[JoshinNC]

Carried Interest Isn't Business Profits

It's LTCG. Don't know what Trump's proposed top rate on LTCG would be, if elected.

[RitaB]

Good question

I'm not trying to start a political discussion, but hoping for clarity on carried interest.

I don't have hedge fund managers in my client list, but my understanding is that they can structure their business so that profits are taxes at LTCG rates, which currently can be up to 23.8%. The Trump tax plan says top rate of 15% for business profits, so it looks to me that they would actually be getting a lower rate. Is my reasoning flawed?

That's a good question. I assume "business profits" means corporation profits. I think the gist of his plan is to stop classifying carried interest as capital gains income and tax it at ordinary income tax rates at the individual level.

[David1980]

Under Trump's proposal both corporate taxes and pass-through entities would get the 15% rate.

"This lower tax rate cannot be for big business alone; it needs to help the small businesses that are the true engine of our economy. Right now, freelancers, sole proprietors, unincorporated small businesses and pass-through entities are taxed at the high personal income tax rates. This treatment stifles small businesses. It also stifles tax reform because efforts to reduce loopholes and deductions available to the very rich and special interests end up hitting small businesses and job creators as well. The Trump plan addresses this challenge head on with a new business income tax rate within the personal income tax code that matches the 15% corporate tax rate to help these businesses, entrepreneurs and freelancers grow and prosper." - https://www.donaldjtrump.com/positions/tax-reform

So what would happen is those who currently structure their income to benefit from the long-term tax rates would simply restructure their income to benefit from the 15% business tax rate instead. I don't expect people would have a hard time figuring out how to make their income qualify.

[Burke]

It's LTCG.

And therein lies the problem: I have never understood the term "carried interest." Do the hedge fund owners simply withdraw LTG profits from the fund for themselves? And what is the amount based on?

[JoshinNC]

Example

And therein lies the problem: I have never understood the term "carried interest." Do the hedge fund owners simply withdraw LTG profits from the fund for themselves? And what is the amount based on?

Moneybags (HF manager) sets up Limited Partnership (LP), naming his HF as the GP with a 1% interest, Mr. Moneybags doles out to himself 20% interest in the LP and sells the rest of the LP interests to investors. Said LP earns $1 billion trading a security, all of which is a LTCG. Because Mr. Moneybags owns 20% of the LP he has a LTCG on his K-1 for $200 million. The argument is that Mr. Moneybags should pay ordinary income tax on the $200 million because Mr. Moneybags made the decisions on which securities to buy, when to buy them and when to sell them. The argument is that Mr. Moneybags should have just charged the LP $200 million to do that work and reported it as ordinary income. The argument is that Mr. Moneybags is getting a tax benefit that "isn't available to common people" (even though most of the people in the LP are "common people" or pension funds that benefit "common people"). The argument is that Mr. Moneybags is making a huge income and is paying a tax rate that "isn't available to others" (Mr. Moneybags is actually paying 20% LTCG tax plus NIIT, plus Medicare surtax on this income).

[TAXNJ]

If legal

Moneybags (HF manager) sets up Limited Partnership (LP), naming his HF as the GP with a 1% interest, Mr. Moneybags doles out to himself 20% interest in the LP and sells the rest of the LP interests to investors. Said LP earns $1 billion trading a security, all of which is a LTCG. Because Mr. Moneybags owns 20% of the LP he has a LTCG on his K-1 for $200 million. The argument is that Mr. Moneybags should pay ordinary income tax on the $200 million because Mr. Moneybags made the decisions on which securities to buy, when to buy them and when to sell them. The argument is that Mr. Moneybags should have just charged the LP $200 million to do that work and reported it as ordinary income. The argument is that Mr. Moneybags is getting a tax benefit that "isn't available to common people" (even though most of the people in the LP are "common people" or pension funds that benefit "common people"). The argument is that Mr. Moneybags is making a huge income and is paying a tax rate that "isn't available to others" (Mr. Moneybags is actually paying 20% LTCG tax plus NIIT, plus Medicare surtax on this income).

Good example. If legal then non issue.

[Burke]

Thank you so much. It could not be clearer. (Except for the "carried interest" moniker. Where on earth did that come from? ) If the LP were not controlling the buys/sells, there would be no issue. But I agree with those who object to the set-up and think at least some part of his distributive income should be treated as reasonable compensation. So it is normal to work for free? What is the difference between this situation and the S-Corp more-than-2% owner/officer who must take reasonable comp vs. distributions?