Grassley Pushes for PE Firm Tax Changes

Federal legislators are mulling a proposal to treat carried interest compensation for private equity and hedge fund professionals as ordinary income rather than capital gains.

The move would instantly propel the biggest pool of private equity compensation into a much higher tax bracket. Salaries and bonuses earned by private equity professionals come from fund management fees and are treated as ordinary income. But the lofty sums they earn above that derive from their 20 percent profit share, or carried interest.

Under current tax law, this carry is taxed at a 15 percent rate reserved for individual long-term capital gains. If the proposal gets adopted, the carry would be treated as ordinary income, and therefore taxed at a 35 percent rate for professionals in the highest tax bracket.

Advocating the proposal is Charles Grassley of Iowa, the ranking Republican on the Senate Finance Committee, which is led by Democratic chairman Max Baucus of Montana. Democrats have placed renewed focus on executive compensation and taxation of the wealthy since retaking control of Congress in January. The fact that a Republican such as Grassley has joined the fray should give this proposal even more momentum.

I think its going someplace, said Richard J. Bronstein, a tax partner at Paul, Weiss, Rifkind, Wharton & Garrison in New York. A representative from the Senate Finance Committee declined to comment except to say that there is no plans for a bill at the moment.

The change in tax treatment for carry would join a growing list of tax initiatives now gaining traction in Congress, including the possibility of raising the top income tax rate from 35 percent to 39.6 percent and increasing the capital gains rate from 15 percent to 20 percent, according to law firm Debevoise & Plimpton.

Notably, both Baucus and Grassley have been critical of alternative investment funds. Because these funds rely so heavily on public pension funds for capital, the lawmakers have questioned whether they operate with sufficient transparency and whether they return enough money to investors.

In a statement, Douglas Lowenstein, the president of the newly formed Private Equity Council, an educational and lobbying association working on behalf of the industry’s largest firms, said the carry-tax issue is one of many topics he plans to discuss as he makes his first rounds through congressional offices.

This story first appeared yesterday at