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Capital Gains Tax Notches Up For Partners; NYC Proposes PE Tax

  • Those making over $400K must pay more
  • Carried interest spared in federal legislation
  • But NYC proposal targets buyout profits

Buyout professionals who earn more than $400,000 individually or $450,000 in taxable income when filing jointly with a spouse will have to pay higher taxes on ordinary income this year. They will pay a top tax rate on ordinary income of 39.6 percent, up from 35 percent last year; they also will have to pay as much as a 20 percent tax, up from 15 percent, on long-term capital gains and qualified dividend income. Carried interest derived from the profit share buyout professionals take on their realized investments is taxed as a capital gain. (Those making more than $200,000 in taxable income or $250,000 when filing jointly also must pay a 3.8 percent “Medicare contribution tax” on investment income.)

Meantime, New York City’s top financial officer and possible contender for mayor in 2013, John Liu, proposed tax hikes last month for big businesses, including private equity firms, and an end to Madison Square Garden’s $15 million annual property tax exemption, according to sister news service Reuters.

As for good news, the law formally known as the American Taxpayer Relief Act of 2012, which President Barack Obama signed in early January, did not specifically target carried interest from realizations, which will continue to be taxed as a capital gain rather than regular income or some mixture, as has been proposed in the past. And Senate Republican Leader Mitch McConnell, speaking Sunday, Jan. 6, on ABC’s “This Week With George Stephanopoulos,” ruled out additional tax hikes on top of the ones included in the so-called “fiscal cliff deal.”

Not all buyout professionals will have to pay higher taxes on income generated this year. Those whose taxable income as individuals is below $400,000 (or $450,000 when filing jointly with a spouse) will continue to pay a top tax rate on ordinary income of 35 percent as well as a 15 percent tax rate on qualified dividend income and long-term capital gains.

But according to the 2012-2013 Holt-Thomson Reuters PE/VC Compensation Report, most managing general partners, senior partners and partners at North American buyout and growth equity shops make more than $400,000 in salary and bonus alone. Even at buyout and growth equity shops with less than $500 million under management the median salary plus bonus for partners/managing directors is $454,000, and it’s far higher at firms managing more assets. Those at the principal/vice president level at buyout and growth equity firms with $1 billion or more in assets under management could also easily be making above the $400,000 threshold under the new tax law.

The proposals by New York City Comptroller Liu include tax hikes on private equity firms, which would help offset his plan for $500 million in tax breaks and reduced fines for 90 percent of the city’s small businesses. Liu is expected to vie for the Democratic mayoral nomination for the election in November.

Specifically, private equity firms could start paying the unincorporated business tax for carried interest or gains from assets being held for investment. The exemption costs New York City about $200 million a year, Liu said.

Liu’s package would use the revenue generated by these and other measures to offset his plan to ease the tax burden for small businesses. Liu proposed ending the city’s general corporation tax for all businesses with liabilities under $5,000—about 240,000 business in the city, or 85 percent of those that currently pay the tax.

His plan would also reduce some fines, as well as exempt businesses that make less than $250,000 in annual income from the city’s unincorporated business tax.

The proposals would have to be approved by the governor and state legislature after a request by the city council.

The city is facing a possible $2.7 billion gap in fiscal 2014 that could grow to $3.8 billion the following year, Liu said.

Hilary Russ is a journalist for Reuters in New York.