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Mnuchin’s Carried Interest Approach Would Make ‘No Difference’

Posted on September 14, 2017 by Stephanie Cumings

Treasury Secretary Steven Mnuchin’s recent statements that carried interest treatment would be repealed only with respect to hedge funds could be difficult to implement and would have only a minimal impact on revenue, tax observers told Tax Analysts.

Robert Willens of Robert Willens LLC said that despite popular perception, hedge funds don’t benefit significantly from the current tax treatment of carried interest because they don’t realize long-term capital gains, which are from the sale of assets held at least one year. Hedge funds “take advantage of short-term swings in the market and they rarely hold securities more than a few days, much less more than a year,” he said. Willens said it would make “no difference” in the amount of taxes hedge funds pay if the administration changed the taxation of carried interest and thus “wouldn’t really have any revenue impact at all.”

Mark Mazur of the Urban-Brookings Tax Policy Center agreed that hedge funds don’t benefit from carried interest taxation the way other entities do. “For many hedge funds, if they’re doing a lot of rapid trading, then all their income is ordinary income anyway, it’s not capital gains.”

Willens said it’s long been a “thorn in the side” of hedge funds that they’re perceived as benefiting from the treatment of carried interest when that’s not the case. “I don’t have a really good explanation of why they’re always analogized to private equity firms, who clearly benefit from it and benefit expensively,” he said.

President Trump advocated reforming the taxation of carried interest during his presidential campaign. Carried interest is the share of profits from an investment fund paid to the investment manager as compensation and is generally taxed at the lower capital gains rate. Former White House Chief of Staff Reince Priebus told CBS This Morning in May that “I think you're probably going to see” the carried interest "loophole" closed in tax reform. “If it was up to the president, it'd be gone,” Priebus said.

However, Mnuchin recently revealed more details about what the administration means by reforming carried interest taxation. Mnuchin said at a forum in Louisville, Kentucky, that the president wants to restrict carried interest treatment for hedge funds, but that he may leave it in place for other types of funds if they create jobs.

“We will close the loophole for hedge funds in carried interest,” Mnuchin said. “What we are focused on is there are many other types of funds that do create jobs and we want to make sure we don’t discourage investment.”

He reiterated those comments September 12 at a conference in New York. Asked how the administration would cope with the complexities of making a distinction between hedge funds and job creators, Mnuchin said, “The good news is we have over a hundred people at the Treasury working on this.” The White House didn’t respond to a request for comment on the proposal being touted by Mnuchin.

Monte A. Jackel of Akin Gump Strauss Hauer & Feld LLP said he was “baffled” by Mnuchin’s comments. He said it’s hard to predict what the details of such a proposal would look like given the complexities involved. Jackel recently outlined some of the complexities of repealing carried interest, both legislatively and administratively.

Jackel said it’s particularly difficult to define what kinds of funds “create jobs,” and that excluding hedge funds from this definition is line-drawing that could result in winners and losers.

“Private equity firms appear more likely to create jobs in the traditional sense as compared to hedge funds, but who’s to say whether buying a company long term will end up creating jobs? How do you measure this? When do you measure this?” Jackel asked. “And just because hedge funds typically have short-term gains in traded securities, who’s to say that indirectly they do not create jobs? I thought what was defined as described by Secretary Mnuchin was not achievable.”

Willens said that targeting carried interest repeal solely at hedge funds through legislative language would be impossible because defining a hedge fund would be too difficult. “There’s nothing close to an accepted definition of a hedge fund, and to try and distinguish it from private equity firms would be futile.”

Mazur said that the issue more generally is that altering carried interest taxation is a complicated endeavor. “People have talked about carried interest in really broad strokes, but when you’re actually writing the legislation, you have to care about a lot of the details,” he said. While carving out exceptions could help prevent legislation from being too broad, those exceptions can be difficult to define, he said.

Industry Opposition

Representatives of the private equity industry are strongly opposed to efforts to alter carried interest taxation and have sought to distinguish hedge funds from other kinds of entities that would be affected. The American Investment Council, a lobbying group for private equity and growth capital firms, sent a letter to the Senate Finance Committee’s chair and ranking minority member in July arguing that changing the tax treatment of carried interest would “nearly double taxes on businesses that facilitate investment and job growth in the United States.”

“While some supporters of the tax increase claim it is only a tax on hedge fund managers, the proposed tax increase is squarely aimed at real estate, private equity, venture capital, and other businesses that make long-term investments that stimulate economic growth, innovation, and job creation,” the AIC said.

The council argues that the current treatment of carried interest is based on sound and settled tax policies. “The first is that long-term capital gains rates are designed to reward entrepreneurial risk-taking to promote investment and growth,” the AIC said. “The second is that partnership profits should be taxed on a pass-through basis.”

But the Patriotic Millionaires, in response to Mnuchin’s comments in Kentucky, accused the Treasury secretary of promoting "a widely-disputed claim of private equity industry lobbyists.”

“Secretary Mnuchin’s friends in private equity are rejoicing today, as the U.S. Treasury is now parroting industry talking points about their alleged benefit to U.S. workers,” the group’s chair, Morris Pearl, said in a statement. “Hundreds of thousands of pink slips tell the real story.” Pearl said the proposal was a “calculated political ploy” designed to simultaneously appease the president’s base as well as “Wall Street billionaires.”

Willens said the proposal may be more of a public relations attempt for the administration to demonstrate its “populist bona fides.”


Democrats have already taken aim at carried interest this year. Sen. Tammy Baldwin, D-Wis., reintroduced the Carried Interest Fairness Act in May, which would tax carried interest income at the same rate as ordinary income. The Joint Committee on Taxation estimated in 2015 that the bill would raise $15.64 billion between 2016 and 2025.

Baldwin sent a letter to Trump September 11 noting that he has stated his support "for closing the carried interest tax loophole on a number of occasions, both during the campaign and as President.” She said  Trump appeared to be backing off that position, citing Mnuchin’s comments that the current carried interest treatment would be eliminated only for hedge fund managers, but for not others, such as private equity managers.

“This exemption would be a classic Washington game of bait-and-switch, quickly becoming a loophole used by investment partnerships and Washington lobbyists to avoid . . . paying their fair share,” Baldwin said.

Meanwhile, a group of House Republicans argued in a June 13 letter to the leaders of the House Ways and Means Committee that the current treatment of carried interest should be retained. “For more than a century, tax law has appropriately defined profits derived from the sale of capital assets as capital gains income,” they said. “Changing that characterization as it relates to carried interest capital gains would arbitrarily punish investors in real estate, venture capital, private equity and other partnerships by treating their gains differently than those of other investors.”