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UCSD Law Professor Dreams Up New Way For Obama To Get Hedge Fund Managers All Riled Up

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It seems all of the sound and fury—and then nothing—surrounding whether to close the carried-interest loophole/raise taxes on hedge and private-equity fund managers may have been (it wasn’t), but was certainly unnecessary. Maybe.

President Obama could change the tax treatment of carried interest with a phone call to the Treasury Department….

The administration has at least two options for acting unilaterally to change the character from capital gain to ordinary income. First, following the logic of a recent court ruling in the ERISA context, it could treat investment funds as a trade or business—thereby turning carried interest from investment income (as it is currently treated) into business income, taxable at ordinary rates. This approach would, however, have collateral tax consequences beyond the fund managers.

A better option would be to revisit the rules that address the taxation of partners who perform services for the partnership. Fund managers enjoy tax benefits because they are treated as partners, not just service providers. But most fund managers put in just 1 percent of the financial capital and reap 20 percent of the profits, plus a steady stream of fee income. So one may reasonably question whether the fund manager really ought to be taxed as a partner and not as a service provider….

If the administration should follow this path, fund managers would pay tax at ordinary rates, just like lawyers, accountants, bankers and other service providers.

How Obama Can Increase Taxes on Carried Interest [DealBook]


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