October 28, 2007
Now we know the score ...
Posted by Victor Fleischer

... of the carried interest bill.  Rep. Rangel introduced a new version of the Levin Bill on carried interest (i.e. the broader House version) as part of his "mother of all tax reform" proposal.  Of greater relevance is the possibility that the carried interest bill will be split off as part of an AMT patch.

$50 Billion.  The Joint Committee on Taxation estimated the revenue from the carried interest legislation at $25 billion over 10 years.  This is a bit lower than my back-of-the-envelope estimate, but still an impressive chunk of change.  When you add in the proposal to end offshore deferral for hedge fund managers, you get about $50 billion, which is about what's needed to pay for the AMT patch.

The loan "workaround."  One workaround to the original Levin bill would be to have the fund manager borrow money from the limited partners at a zero or below market rate of interest, followed by an investment of the loan proceeds in the fund.  The net result would be a mix of ordinary income and capital gain.  The new bill shuts down this strategy, treating a partnership interest purchased with proceeds of such a loan as an "Investment Management Services Partnership Interest," rather than a normal capital interest in the partnership.   As such, any distributions to the service partner/fund manager would be treated as ordinary income.  I would imagine that this amendment increased the revenue estimate by 20% or so.  There is some additional language that shuts down similar avoidance strategies.

Offshore Deferral.  I find it curious that hardly anyone is talking about the proposal to end offshore deferral for hedge fund managers.  Under current law, hedge fund managers achieve deferral by organizing the fund in the Caymans and electing to be treated as a foreign corporation under U.S. law.  (Because the Cayman Corp is engaged in securities trading, it's not treated as effectively connected with a US trade or business, even if the fund managers are working in Greenwich or elsewhere in the US.)  In lieu of carried interest, the hedge fund managers structure their comp as an "incentive fee" from the Cayman Corp.  They then set aside a large portion of their fee for deferral and reinvest the money (still using pretax dollars) offshore.  The House legislation would end this strategy for corporations organized in certain tax haven jurisdictions. 

The Senate.  It's still not clear to me what's going on in the Senate.  As I understand it, the Senate Finance Committee would rather waive the pay-go rules and provide an AMT patch without paying for it.  It's not at all clear what's going on with carried interest--Schumer announced that he'd be introducing a new bill, but I haven't seen it introduced.  At this point, I'd bet on the offshore deferral bill (introduced by Kerry) getting passed before carried interest.  The Blackstone/PTP bill still seems to be alive as well.

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