Both President Trump and Capitol Hill Democrats head into negotiations over tax reform vowing to put the squeeze on hedge fund managers by closing the carried interest tax loophole — a point of agreement that held out promise for becoming a foundation for a once-in-a-generation deal.
There’s one problem: Hedge fund managers don’t use the tax break for carried interest — a share of investment profits earned by money managers (usually 20 percent) that are taxed at the capital gains rate of 15 percent rather than at the top rate of 39.6 percent on ordinary income.
The tax break only applies to investments held for more than a year, and hedge fund managers make most of their money in quick trades. To reduce their tax bills, they are more likely to park their huge earnings — the top 25 hedge fund managers combined made $10.9 billion last year, according to Forbes — in offshore tax havens such as Bermuda.
It explains why the hedge fund industry shrugs off persistent attacks on their profession from politicians, usually on the left, and calls for an end to the tax code’s special treatment of carried interest.
But those that benefit from the tax break — private equity, venture capitalists, real estate investors — are just as confident it will survive Mr. Trump’s reforms.
“There’s no interest in changing the long-term capital gains treatment,” said James Maloney, vice president of public affairs at the American Investment Council. “It is only for the short-term capital gains treatment and re-characterizing that as ordinary income. But the rate would not change because it is already equivalent to the ordinary income rate.”
The carried interest loophole was supposed to be as good as dead in the tax rewrite. While that seems less certain with each passing day, it isn’t the first time the tax break that Americans love to hate beat the odds.
President Obama moved to eliminate it in his first term but was unsuccessful. He made it an issue again in the 2012 race against Republican nominee Mitt Romney, who made a fortune as a venture capitalist.
Mr. Trump pivoted to his tax reform agenda last week after the failure of his bid to repeal Obamacare, setting an ambitious goal of passing the tax code overhaul before Congress’ summer recess in August.
Mr. Trump has hinted that his plan is moving closer to the House GOP blueprint that reduces the current seven tax brackets, with a top tax rate of 39.6 percent, to three brackets: 12 percent, 25 percent and 33 percent.
The plan is expected to call for lowering the corporate tax rate to 20 percent, down from 35 percent, the highest rate among developed nations.
However, when the president gave up on the GOP bill to repeal and replace Obamacare, he also gave up nearly $1 trillion in tax cuts and commensurate spending cuts for Medicaid, measures that would lower the budget baseline and make it easier to slash tax rates without adding federal debt.
“We are all waiting to see if the White House and the House Republicans can agree on anything,” said Sen. Claire McCaskill, a Missouri Democrat on the Senate Finance Committee. “They clearly couldn’t agree on repealing Obamacare. So it’s not clear to me that they are going to agree on tax reform.”
She said the plan’s treatment of special interests would be a key test.
“The president made a commitment to the country about carried interest, and I’m expecting the country will hold him true to that commitment,” said Ms. McCaskill.
When Mr. Trump jumped on the carried interest band wagon during the campaign, Democrats embraced it as one of a few issues where they could potentially work with the president.
“The Trump pledge on carried interest turned out to be just another head fake,” Sen. Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee, said earlier this month in a speech at the Tax Policy Center.
Mr. Trump’s tax reform plan is still being written, but he has signaled what will be in it and what won’t be in it.
The Trump administration and House Republicans have backed away from the carried interest tax loophole, which does benefit venture capitalists, private equity, real estate and energy speculators who hold onto assists for more than a year.
“We said during the campaign that we think hedge funds should be taxed, and I think that is something that we will put into the plan,” Treasury Secretary Steven T. Mnuchin said at a forum last week hosted by Axios.
Mr. Mnuchin, a former hedge fund manager, said they would tread carefully on carried interest.
“We are going to look carefully at what the impact is to other areas so we don’t dis-incentivize what’s very important investment by pension funds, by estate funds, by lots of other institutional investors, retail investors into infrastructure, real estate, energy — these are all things that we need to continue big investment” in, he said.
“You know the president wants to spend $1 trillion on infrastructure, and a significant component of that we expect to be funded by private enterprise,” said Mr. Mnuchin.
• S.A. Miller can be reached at smiller@washingtontimes.com.
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