Additionally, opponents see these managing partners reaping an unfair tax advantage, as it is the investor's money that is at risk. However, some managing partners do invest a significant amount of their own capital. By applying the ordinary tax rate to all of an investment manager's income, these opponents overlook the fact that some of the managing partner's own money is at risk.
Impact of Changing Carried Interest Rules
Changing this favorable tax treatment would subject carried interest to federal self-employment taxes and also to federal ordinary income taxes, currently at the top rate of 39.6 percent. This change would be a huge increase in effective tax rates because of the combination of income and self-employment taxes. In addition to the federal taxes, classifying carried interest as ordinary income may make the fund managing partner liable for various state and local income taxes. In addition to affecting the managing partner's bottom line, changes in the carried interest rules also could affect how investment funds and their managing partners structure their agreements. Attorneys should watch for further developments in the ongoing tax debate, and keep an open line of communication with investment funds and their managing partners about the potential impact of various proposals.
Michael Sexton is a tax manager with Wouch Maloney & Co. He has more than 13 years of public accounting experience and is knowledgeable in a wide variety of tax matters. Contact him at 215-675-8364 or visit www.wm-cpa.com.