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House Bill Seeks Hedge Fund Tax Reform

House Bill Seeks Hedge Fund Tax Reform

Friday, 29 June 2007 08:00

The House introduced a bill last week that would more than double the taxes paid by hedge fund and private equity managers. Rep. Sander Levin (D-MI), along with House Ways and Means Committee Chairman Charles Rangel, and Rep. Barney Frank (D-MA), introduced the bill on June 22, 2007, that would ensure that carried interest, the share of a funds profits taken by managers as compensation for investment management services, is taxed as ordinary income.

Under present law, carried interest is taxed at the 15-percent capital gains tax rate, not the income tax rate of up to 35 percent. The low tax rate on carried interest has helped top hedge fund and private equity managers amass fortunes, and has been a topic of debate for some time.

The bills introduction comes amidst widespread media coverage of the $4.13 billion initial public offering of Blackstone Group LP (BX). Blackstone announced in March of 2007 that it would sell 10 percent of the firms equity to the public. Since the announcement, news outlets and legislators alike have hotly discussed all facets of the offering in light of founder Steven Schwarzman’s $700 million cash take.

Levin argues that the carried interest compensation is being paid to fund managers for their providing a service, and as such, should be taxed as income, just as any other American who is providing services. Congress must ensure that our tax code is fair. We have to be sure that the lower capital gains tax rate is not being inappropriately substituted for the tax rate on wages and earnings, said Rep. Levin.

Critics of the bill suggest that the proposed tax revisions will hurt the U.S. venture capital industry, which provides much needed financing to emerging businesses. If the next Microsoft or Google goes unfunded to pay tax liabilities it becomes much harder to justify the few billion dollars in tax revenue to be gained from the changes.

Managers who invest their own money into their funds will still be able to enjoy the capital gains rates applicable to their investment returns, but the success of the Levin Bill would decrease a key motivator for hedge fund managers who strive to create value for their investors as well as themselves. It remains to be seen what, if any, changes will result from the increased attention and discussion of hedge fund and private equity operations.

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