Obama Proposes Taxing Carried Interests (Promotes) as Ordinary Income

In one of his latest proposals, President Obama has raised the issue of taxing carried interests. In the real estate investment world, carried interests are often referred to promotes. Promotes are a way for investment funds to share in the success of the investment; it is essentially a right to receive a specified share of the profits that an investment fund generates, without the contribution of a corresponding share of the capital.

An example would be that a real estate developer puts a deal together and brings in a money partner that puts up 100% of the equity. A typical arrangement would be one where the developer gets his fees, in addition to a “Promote” of say 20% of the profits above an agreed upon amount.

Under existing tax rules, carried interests are taxed at the capital gains rate. President Obama’s proposal would have carried interests taxed as Ordinary Income, which would be a significant tax hike on such arrangements. Promotes are used heavily in the Venture Capital, Private Equity, and Real Estate world, and such a tax would have a significant impact on Silicon Valley.

Still though, the current tax treatment of carried interests (as capital gains) demonstrates the type of tax inequality which investors such as Warren Buffet have often cited. If a money manager would generate $100M for themselves almost  entirely through a promote structure, then under current law, that individuals’s effective federal tax rate would be around 15%, while a typical clerical employee earning say only $40,000 would pay a higher tax rate since their income is classified as Ordinary Income.

Irrespective of the politics, such a tax will have a significant impact on investors if it gets passed. The President’s proposal has the tax kicking in at 2011.

Similar Posts:

• Legislative Update: Congress Looking To Raise Carried Interest Tax
• A Quick Thought on Carried Interest
• Welcome Back Risk
• Tax Implications of Loan Forgiveness
• Capital Gains Tax Hikes Loom; Proposition 13 Tax At Risk

Leave a comment