Buyout, Hedge-Fund Managers Could Pay $24 Billion More in Taxes

Date: Friday, February 27, 2009
Author: Jason Kelly and Katherine Burton, Bloomberg

Executives at buyout, venture-capital and hedge-fund firms will pay an estimated $24 billion more in taxes over nine years if President Barack Obama gets his way.

Obama’s 2010 budget proposal, released today, proposes raising taxes on the managers by treating carried interest, the portion of profits they take from successful investments, as ordinary income instead of capital gains. That change would boost the tax rate, starting in 2011, to 39.6 percent for most executives from the 15 percent they now pay.

The proposal applies to partnerships that receive a portion of the profits they make for their clients. It will likely reignite a debate begun in 2007 amid the biggest buyout boom in history, when firms including Blackstone Group LP and Och-Ziff Capital Management Group raised their profiles through public stock listings. While the House of Representatives approved the tax change that year, the measure wasn’t taken up by the Senate.

“Obama and his team are up for a fight here,” said George Teixeira, a managing director with accounting firm RSM McGladrey in New York. “They’re missing key components of what these industries do.”

The change could hurt funds’ abilities to hire and retain managers, Teixeira said. The majority of pay at hedge funds and private-equity firms is drawn from their share of clients’ profits, typically 20 percent of the gains.

“If they have an incentive to give, they can keep their talent,” he said. “If that’s not there, it’s going to be tough to keep people.”

No Exemptions

Senior Treasury officials told reporters today that the tax increase would apply to all partnerships that use the carried interest structure and wouldn’t exempt any industries.

Venture-capital firms have sought to be excluded from any tax rise. The policy would also affect executives of real estate and oil and gas partnerships.

Hedge-fund executives typically get a carried interest, though little of it qualifies for capital gains rates under current law because the funds typically take short-term positions in the market. Those executives would face higher taxes on any profits from “side-pocket” funds they hold for hard-to-sell investments.

Private-equity firms have more than $500 billion on hand and are looking for ways to invest that money during the economic crisis, the Private Equity Council, an industry trade group, said today in a statement.

“We look forward to working with the Obama administration and the Congress to develop a tax policy that ensures fairness, raises sufficient revenue, and preserves incentives for private capital to invest in and grow companies so the American economy comes back stronger than ever,” Douglas Lowenstein, president of the Washington-based group, said in the statement.

To contact the reporter on this story: Jason Kelly in New York at jkelly14@bloomberg.net; To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net