FacebookTwitterGoogle+RedditEmail

Taxing Carried Interest

by EILEEN APPELBAUM

Private equity firms recruit investors—pension funds, endowments, sovereign wealth funds, hedge funds, wealthy individuals—for an investment fund. The private equity fund is structured as a partnership in which the sponsoring private equity company is the general partner and the investors in the fund are limited partners. The investment fund acquires a portfolio of operating companies with the expectation that the fund will make a profitable exit from the investments in a few years. The general partner (the private equity firm) makes the decisions about which companies to buy, how they should be managed, and when they should be sold. The limited partners share in any gains (or losses), but do not have a say in decision-making. The private equity firm typically sponsors multiple special purpose private equity investment funds, each of which is structured as a separate partnership.

Firms that sponsor private equity funds operate on a “two and 20” model. They typically collect a flat 2 percent management fee on all money committed to the investment fund by the limited partners. The management fees cover the costs of managing the fund and its investments, including payments to members of the private equity firm for work they perform.

The private equity firm that sponsors the fund—the general partner in the fund—also receives 20 percent of all investment profits once a hurdle rate of return has been achieved. The remaining profits are distributed to the limited partners in proportion to the capital that they invested in the fund and put at risk. The profits that are received by the private equity firm are referred to as carried interest. They are distributed to the partners in the private equity firm and taxed at the lower capital gainsrate, currently 15 percent, not at the top personal income rate of 35 percent. (It is worth noting, as Paul Krugman does, that long-term capital gains were taxed at close to 30 percent from 1986 through 1997 when they were reduced to 20 percent; the current very low rates only started in 2003).

Private equity firms argue that the 20 percent of a private equity fund’s profits that they earn are a return on the equity they have invested—the capital they have put at risk—and should, therefore, be treated as capital gains and taxed at the lower rate.

Typically, however, a private equity firm contributes $1 to $2 to the private equity fund for every $100 the limited partners have invested in the fund. Thus, 1 to 2 percent of the fund’s profits are a return on the private equity firm’s investment in the fund; the remaining 18 percent is a form of profit sharing by the private equity firms’ partners. As with other forms of performance-based pay, these earnings should be taxed as ordinary income and not at the 15 percent capital gains rate.

Eileen Appelbaum is a senior economist at the Center for Economic and Policy Research and the co-author of ‘Leaves That Pay: Employer and Worker Experiences With Paid Family Leave in California.’

This article originally appeared in Economic Intelligence (U.S. News & World Report)

More articles by:

CounterPunch Magazine

minimag-edit

bernie-the-sandernistas-cover-344x550

zen economics

Weekend Edition
December 09, 2016
Friday - Sunday
Jeffrey St. Clair
Roaming Charges: Nasty As They Wanna Be
Henry Giroux
Trump’s Second Gilded Age: Overcoming the Rule of Billionaires and Militarists
Andrew Levine
Trump’s Chumps: Victims of the Old Bait and Switch
Chris Welzenbach
The Forgotten Sneak Attack
Lewis Lapham
Hostile Takeover
Joshua Frank
This Week at CounterPunch: More Hollow Smears and Baseless Accusations
Paul Street
The Democrats Do Their Job, Again
Vijay Prashad
The Cuban Revolution: Defying Imperialism From Its Backyard
Michael Hudson - Sharmini Peries
Orwellian Economics
Erin McCarley
American Nazis and the Fight for US History
Mark Ames
The Anonymous Blacklist Promoted by the Washington Post Has Apparent Ties to Ukrainian Fascism and CIA Spying
Yoav Litvin
Resist or Conform: Lessons in Fortitude and Weakness From the Israeli Left
Conn Hallinan
India & Pakistan: the Unthinkable
Andrew Smolski
Third Coast Pillory: Nativism on the Left – A Realer Smith
Joshua Sperber
Trump in the Age of Identity Politics
Brandy Baker
Jill Stein Sees Russia From Her House
Katheryne Schulz
Report from Santiago de Cuba: Celebrating Fidel’s Rebellious Life
Nelson Valdes
Fidel and the Good People
Norman Solomon
McCarthy’s Smiling Ghost: Democrats Point the Finger at Russia
Renee Parsons
The Snowflake Nation and Trump on Immigration
Margaret Kimberley
Black Fear of Trump
Michael J. Sainato
A Pruitt Running Through It: Trump Kills Nearly Useless EPA With Nomination of Oil Industry Hack
Ron Jacobs
Surviving Hate and Death—The AIDS Crisis in 1980s USA
David Swanson
Virginia’s Constitution Needs Improving
Louis Proyect
Narcos and the Story of Colombia’s Unhappiness
Paul Atwood
War Has Been, is, and Will be the American Way of Life…Unless?
John Wight
Syria and the Bodyguard of Lies
Richard Hardigan
Anti-Semitism Awareness Act: Senate Bill Criminalizes Criticism of Israel
Kathy Kelly
See How We Live
David Macaray
Trump Picks his Secretary of Labor. Ho-Hum.
Howard Lisnoff
Interview with a Political Organizer
Yves Engler
BDS and Anti-Semitism
Adam Parsons
Home Truths About the Climate Emergency
Brian Cloughley
The Decline and Fall of Britain
Eamonn Fingleton
U.S. China Policy: Is Obama Schizoid?
Graham Peebles
Worldwide Air Pollution is Making us Ill
Joseph Natoli
Fake News is Subjective?
Andre Vltchek
Tough-Talking Philippine President Duterte
Binoy Kampmark
Total Surveillance: Snooping in the United Kingdom
Guillermo R. Gil
Vivirse la película: Willful Opposition to the Fiscal Control Board in Puerto Rico
Patrick Bond
South Africa’s Junk Credit Rating was Avoided, But at the Cost of Junk Analysis
Clancy Sigal
Investigate the Protesters! A Trial Balloon Filled With Poison Gas
Pierre Labossiere – Margaret Prescod
Human Rights and Alternative Media Delegation Report on Haiti’s Elections
Charles R. Larson
Review:  Helon Habila’s The Chibok Girls: the Boko Haram Kidnappings and Islamist Militancy in Nigeria
David Yearsley
Brahms and the Tears of Britain’s Oppressed
FacebookTwitterGoogle+RedditEmail