Whitehouse, Wyden Bill Ensures Private Equity Moguls Pay Fair Share in Taxes

Washington, DC – Senator Sheldon Whitehouse (D-R.I.) and Senate Finance Committee Chair Ron Wyden (D-O.R.) today introduced legislation to close the carried interest loophole and ensure hedge fund managers and private equity CEOs pay their fair share in taxes.

Unlike other bills, the senators’ bill would close the entire carried interest loophole—re-characterization of income from wage-like income to lower-taxed investment income and deferral of tax payments. Previously introduced bills address half of the problem—re-characterization of income.

The Joint Committee on Taxation (JCT) estimates that Whitehouse and Wyden’s bill would raise $63 billion over 10 years, whereas previously introduced bills that did not address deferral of tax payments would raise just $15.6 billion over 10 years.

“Americans have had enough of hedge fund tycoons using this special carve out to pay lower tax rates than their drivers. We need to rebuild our tax code to guard against the ultra-rich and corporations scheming to avoid paying their fair share. Our bill is a good place to start,” Whitehouse said.

“One of the most indefensible loopholes in the tax code allows wealthy private equity managers to be taxed at lower rates than nurses treating COVID patients and avoid paying any tax year after year after year. This is an issue of fairness,” Wyden. “Importantly, my bill closes the entire loophole—private equity managers will no longer be able to defer paying tax for years, if not decades. Nurses treating COVID patients can’t defer paying taxes for years—neither should the private equity managers.”

“The carried interest loophole is an absurd, regressive loophole with no credible economic justification. Millionaire fund managers do not deserve preferential tax treatment on income they earn managing other people’s investments. It’s time for Congress to pass the Ending the Carried Interest Loophole Act and close this ridiculous loophole that has allowed some of the wealthiest people in the country to cut their tax bill nearly in half,” Morris Pearl, former managing director at BlackRock, Inc., and Chair of the Patriotic Millionaires, said.

“This legislation will ensure that tycoons from private equity, real estate, and hedge funds are taxed the same way as teachers, truckers and nurses. It does this by closing the egregious carried interest loophole so that income generated through wealth is treated the same as income from wages. The rich should not get to pay a top tax rate of 20% on investment income when everyone else pays a top tax rate of 37% on wage income. It’s time the tax system rewarded work not wealth, and this is a first step towards that goal,” Frank Clemente, executive director at Americans for Tax Fairness, said.

To prevent the re-characterization of income, fund managers would be required to recognize annual compensation that would be taxed at ordinary income rates and subject to self-employment taxes. Annual compensation would be determined using the estimated forgone interest on an implicit interest-free loan from investors to the fund manager at a prescribed interest rate.

To end deferral of tax payments, the bill treats transactions between fund managers and investors as occurring outside the partnership, decoupling compensation from future sales of investments and ensuring the value of the fund manager’s carried interest is taxed from the outset. Under current law, the fund manager’s carried interest is taxed as income from the partnership, which allows the deferral of tax payments until future investment sales.

To account for the re-characterization to wage-like income and avoid double taxation, the fund manager would also realize a long-term capital loss equivalent to the annual compensation, which could offset the fund manager’s future long-term capital gain from sale of an investment. As with all capital losses, the loss could be used to offset long-term capital gains or carried forward.

For example, if the fund manager receives a 20 percent carried interest in exchange for managing investors’ capital of $100 million, and the prescribed interest rate for the tax year is 14 percent, the fund manager would pay the top ordinary income tax rate of 40.8 percent tax on $2.8 million in deemed compensation.

Text of the legislation is available here.

A one-pager summary of the legislation is available here.

A detailed summary of the legislation is available here.

JCT’s revenue estimate (in billions) is included below.