The BNA reported on a September 19 discussion of carried interest at the American Enterprise Institute involving Vic Fleisher (Illinois), David Weisbach (Chicago) and AEI scholar Alan Viard. Weisbach stated his position against the proposed bill for taxing carried interest, asserting that the capital gains distinction is too "vague" and so it would be inappropriate to change the taxation of carried interest on the claim that it represents something more like ordinary income than caital gains. Vic Fleisher reiterated his position (with which I agree) that carried interest earned by managers of private equity firms (whether buyout or venture capital) is compensation and should be taxed at ordinary rates. See also Vic's post on conglomerate blog on the question of separating out venture capital firms for special treatment as the national association has requested.
Weisbach's point about the difficulty of distinguishing capital gains from ordinary income is on point in this respect--the categorization is easy at the extremes of a person who has been a passive investor in stocks who sells stocks held for many years (capital gains) and a person who has no financial assets other than a bank account who is a construction worker paid an hourly wage for hours actually worked (ordinary income). We say that an entrepreneur who establishes a business with a little bit of money and a lot of sweat equity earns capital gains when he sells the business after a number of years. The entrepreneur should receive a salary from the business profits as the business develops, so that the capital gain represents the appreciation on his original investment. In contrast, a sculptor who builds a masterpiece with a little bit of money and a lot of sweat equity earns ordinary income when he sells the product of his labor.
Money managers do not seem to raise particularly hard issues. The only cause for thinking they may be entitled to capital gains treatment on some of their carried interest is because of the use of the partnership form, which allows profits interests to be received tax free and allows allocations of capital gain income to that profits interest in the same way that it is allocated to a partner who has actually contributed capital rather than performing services. What is problematic is the concept of a profits interest in a partnership that can be received for performing services without being taxed as services income.
Recent Comments