Proposed "Carried Interest" Tax Purports to Soak Wall Street But Hits Family Businesses For the time being, the Senate has again abandoned efforts to impose a "carried interest tax" on venture capitalists, investors, and managers of family businesses. The tax would have increased the 15% capital gains tax rate on certain investors' profits to the top income tax rate, which is scheduled to hit 39.6% on January 1st (H.R. 4213). The share of investors' profits is called "carried interest." It might appear at first glance that it's perfectly fine for investment managers to be taxed at higher rates on their "carried interest." But venture capitalists and investors don't reside exclusively on Wall Street. The law was written so broadly that it could have hit approximately 6.5 million people invested in real estate partnerships that own anything from a single dwelling to sizable commercial properties. The proposed legislation attempts to sway middle America by couching the carried interest tax as imposing a higher rate on "investment management services" and "investment managers" who work for Wall Street houses.
In reality, the proposed legislation could have imposed a higher tax rate on any partnerships invested in particular assets. The higher rates would apply to investment gains and also to gains from the sale of the partnership, and therefore, a sale of the family business would not qualify as a capital gains transaction. Family operations are commonly formed as partnerships and managed by a family member. Under the proposed legislation, the managing family member could be subject to the "carried interest tax." For a family partnership to gain liability protection and also not be subject to the higher taxes, an outsider – not a family member -- would have to manage the partnership. The House version of the legislation exempted family farms and ranches held in partnerships. Other family partnerships would have had to wait for the Treasury Department to exempt them through regulations. Although the proposed legislation is dead for now, it is likely to reemerge as efforts to plug the federal deficit mount. The increased carried interest tax may be reintroduced in some other form. If so, watch carefully to see how the "carried interest" tax will hit families that are well beyond the alleged targets of the legislation, and communicate any concerns to your representatives in Congress. Dan A. Penning