The US House of Representatives is once again considering legislation that would effectively double the tax rate on GP incentive pay by treating carried interest as ordinary income. Not only would this be a blow to managers’ potential compensation, but characterising carried interest as salary would also subject firms to further payroll tax requirements.
Under the Tax Extenders Act of 2009 as written, carried interest would be characterised as ordinary income, which is subject to tax rates as high as 35 percent. Under President Obama’s fiscal year 2010 budget, the highest tax rate would be increased to 39.6 percent. Currently, carried interest is characterised as capital gains, and is subject to a 15 percent tax rate.
As “ordinary income”, carried interest would be subject to social security taxes as well as Medicare contributions, said Richard Bronstein, a partner in the tax practice of law firm Paul, Weiss, Rifkind, Wharton & Garrison. The social security tax requirement would present an additional burden, but there is a limit on personal contributions that is typically met with taxes from the manager’s salary and bonus.
There is no ceiling on how much an individual pays in Medicare taxes, however, meaning that 2.9 percent flat rate would apply to the total amount of salary, bonus and carry. For a GP that earns $1 million in carry in a year, the Medicare contribution would represent an additional $29,000 in taxes under the new bill.
Under the bill, any gains or losses on the disposition of an investment services partnership interest would be taxed as ordinary income as well. Had such a measure been in effect before the Blackstone IPO in 2007, CEO Steve Schwarzman’s $703 million payout that year would have been subject to an additional $20 million in taxes.
The bill is estimated to raise $24.616 billion over 10 years. The House has passed similar legislation twice before: first as part of HR 3996, where it passed by a vote of 216 to 193, and second as part of HR 6275, where it passed by a vote of 233 to 189, with 10 Republicans joining with 223 Democrats in support. In both instances the respective bills failed to get past the Senate.