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Tax on Carried Interest Moving Closer to Reality

A new proposal to tax carried interest as ordinary income was just attached to a larger tax and spending bill that could be voted on by the House as early as tomorrow.

A new proposal to tax carried interest as ordinary income was just attached to a larger tax and spending bill that could be voted on by the House as early as tomorrow.

The bill would have a huge impact on private equity, venture capital and other private partnerships that rely on carried interest as their main source of income. The move would also impact some hedge funds that pay significant long-term capital gains. Washington has been toying with the tax increase for nearly three years, but the the current bill, sponsored by Sen. Max Baucus and Rep. Sander Levin, marks the first time the Senate and the House have come together on the issue.

Venture capital firms, real estate and energy partnerships have lobbied hard to be excluded from the tax increase, arguing that it will hurt start-ups looking to raise capital. But that effort has seemed to fail.

A summary of the bill, cited by Bloomberg, said it would allow carried interest that reflects return on invested capital to continue to be taxed at the lower capital gains rates. For other funds, “the bill would require investment fund managers to treat 75 percent of the remaining carried interest as ordinary income,” the summary said.

One only has to look at KKR’s latest S-1 filing to understand how significant the tax increase will be.

If the changes suggested by the administration or any of the proposed legislation or similar legislation were adopted, income attributable to carried interest may not meet the qualifying income requirements under the publicly traded partnership rules, and, therefore, we could either be precluded from qualifying as a partnership for U.S. federal income tax purpose or be required to hold interests in entities earning such income through a taxable U.S. corporation. If we were taxed as a corporation, our effective tax rate would increase significantly. The federal statutory rate for corporations is currently 35%. In addition, we would likely be subject to increased state and local taxes. Therefore, if any such legislation or similar legislation were to be enacted and apply to us, it would materially increase our tax liability, which could well result in a reduction in the market price of our common units.

In addition, if the proposed legislation is adopted, it could increase the amount of tax KKR's principals and other professionals would be required to pay, thereby adversely affecting KKR's ability to offer attractive incentive opportunities for key personnel.


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