US House of Representatives passes carry tax hike

The bill, which would more than double federal taxes on carried interest, faces an uphill battle in the Senate.

The US House of Representatives has for the second straight year passed a bill that would tax carry as ordinary income, a rate of up to 35 percent, rather than as capital gains at 15 percent.

The revenue-generating measure is contained within the Alternative Minimum Tax Relief Act 2008, which was passed yesterday by a vote of 233 to 189. Representatives voted along party lines, with mostly Democrats supporting the bill and Republicans opposing.

The proposed tax rate change would generate a revenue windfall of just less than $31 billion (€20 billion) over the next 10 years, according to projections from the Joint Committee on Taxation.

This would be used to help counterbalance some of the $61.5 billion loss in tax revenue that would result from exempting roughly 26 million US citizens from the Alternative Minimum Tax (AMT), an antiquated levy designed four decades ago to prevent high-income taxpayers form utilizing a plethora of tax loopholes.

The AMT rate was not pegged to inflation, and now threatens to snag middle income families with a minimum tax rate of 26 percent. It is widely believed that allowing the AMT to take effect would engender middle class hostility to the Democrats, who control both houses of Congress.

A slightly different version of the bill was approved by a vote of 216 to 193 last year. Despite the wider approval margin this year, the carry tax faces an uphill battle in the Senate, which rejected a similar measure last December amid intense lobbying from the private equity, venture and hedge fund communities.

“Democrats are not very confident they can force the Senate to agree to this AMT legislation,” Dustin Stamper, legislative affairs partner in the US National Tax Office of global accounting firm Grant Thornton, told PERE's sister website PEO.

The White House has threatened to veto the bill in its current form, and Senate Finance Committee Chairman Max Baucus, a Democrat from Montana, reportedly said “Why go through the motions?” with regard to again including the carry provision as part of an AMT fix, according to The Washington Post.

Political observers from the private equity community say that the real battle over carry will likely come sometime next year, after the election of a new US president and Congress.

Presumed Democratic presidential nominee Barack Obama has repeatedly expressed his disappointment over the tax hike’s defeat last year. Republican nominee John McCain has argued against changing the tax treatment of carry and has pushed for a lowering of the capital gains tax rate.

“[No matter who is elected] there’s going to be some serious action on taxes in general,” said Stamper. “Certainly every offset including this one is going to be on the table.”