Carried Interest Taxation

So I just read that Biden wants to start taxing carried interest at ordinary income rates. As someone that just reached the holy grail of carry, I'm punching air because it sounds like bs, but tbh have no idea what it means. Was it previously only taxed upon realization whereas now he wants to mark it to market and tax you on those gains annually? Won't we just find a way to value our carry at minimal amounts until it is actually realized if he does go through with this?

Can some senior monkeys with experience / actual carry shed some light on this?

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Apr 29, 2021 - 1:07pm

It's currently taxed as capital gains, whereas the proposed plan would treat it as ordinary income. A proposal like this comes up basically every year, so I'm not sure of the political likelihood of it actually passing.

Another part of his plan would increase the cap gains rate, which is effectively doing the same thing. My guess is the carried interest loophole remains, but cap gains tax does increase (though not as high as Biden's initial draft is suggesting).

Apr 29, 2021 - 2:28pm

Sounds like some vestigial occupy wall st party platform rhetoric. Will changing this materially impact the nation's budget deficit? Methinks not. Does it make Pelosi/KH/Biden look like they are taking on the rich. Very much yes.

This is dumb for several reasons. Carry is not ordinary income, payout occurs after taking on risk and creating value with no basis to offset the gain, which if I am not mistaken is why the CG rate was recommended in the first place. Secondly, their approach to monetary policy does not even care if there is a deficit or not, they will print to plug, so why go after higher taxes?

Disclaimer: I fully intend to take advantage of the loophole   

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  • Analyst 3+ in RE - Other
Apr 29, 2021 - 2:33pm

If we started from scratch and carry interest was treated as ordinary income, nobody would bat an eye. 

The problem is they were giving out free kool aid for the rich and now they are trying to take away the punch bowl. 

I'm fine with it. 

  • Investment Analyst in RE - Other
May 1, 2021 - 12:21am

If you're a vp earning carry are you getting it on your w-2 like ordinary income? Or do you actually get given a piece of the GP vehicle that you own? Or what?

  • Associate 1 in RE - Comm
May 1, 2021 - 9:34am

The annoying thing is this doesn't hurt the partners with 100m+ net worth. Or the mega funds. 
 

It hurts the VP or director at a startup fund who is taking $150k base and primarily getting paid in carry. That $500k in pre-tax carry is now $280k instead of $400k. Thats a meaningful pay cut. While previously it might have been worth it to work for an entrepreneurial firm and take a career risk in exchange for carry / upside, you're now better off taking the safe base + bonus path at a LifeCo or asset manager. So that entrepreneur who started his own fund is now going to have a hard time finding employees to take that risk with him. 
 

As always it's the upper middle class and small / medium sized businesses who gets fucked. Starwood will be fine, senior partners who have already made their tens of millions will be fine. It's young, aspirational employees and businesses who get screwed.

May 1, 2021 - 12:08pm

Very true. But you may see an adjustment where in future Funds, the Partners give up more of the carry pool to 'make the employees whole on a post tax basis' so that they can continue to compete for talent. This may happen, it may not. It'll be interesting to see where the market goes. But if all of a sudden you see a push for base+bonus ordinary W2 income, you may see a shift where a larger portion of the carry pool becomes part of compensation so that firms don't need to adjust salary and therefore current cash outlay.

Additionally, it's a push and pull and not as simple. There will still be greater upside, or at least greater perceived upside, from getting carry than straight w2 compensation. From my understanding of the current market place, the PE Fund employees make the same (if not slightly more) cash compensation as the Life Co Employees, but the PE employees get a portion of the carry pool which is the kicker. The Life Co employees will also get long term incentives (with a slightly different structure and it's technically not carry - it's more like a phantom carry, but pays out similar to carry after vesting). The difference is, on the whole, Life Co Employees are just paid less (W2 income base + bonus and long term incentives) as the Life Co market for salaries is technically lower. 

May 3, 2021 - 1:06pm

The annoying thing is this doesn't hurt the partners with 100m+ net worth. Or the mega funds. 
 

It hurts the VP or director at a startup fund who is taking $150k base and primarily getting paid in carry. That $500k in pre-tax carry is now $280k instead of $400k. Thats a meaningful pay cut. While previously it might have been worth it to work for an entrepreneurial firm and take a career risk in exchange for carry / upside, you're now better off taking the safe base + bonus path at a LifeCo or asset manager. So that entrepreneur who started his own fund is now going to have a hard time finding employees to take that risk with him. 
 

As always it's the upper middle class and small / medium sized businesses who gets fucked. Starwood will be fine, senior partners who have already made their tens of millions will be fine. It's young, aspirational employees and businesses who get screwed.

This only makes sense if you assume the world ends tomorrow.

As with everything else in life, businesses will adjust.  Either they'll pay more or give more carry.  That simple.

May 12, 2021 - 3:26pm

I think thats life in general, really. Poor people don't really have much of any resources to be taken from them and the truly wealthy have the resources to shuffle shit around to minimize their exposure, and simply bend the tax code when they need that to happen. The guys in the middle (or upper end of the middle) are the only ones with enough resources to be asked to pay for something but without the resources to effectively combat that increase. The AMT was a pretty good example of this...minor millionaires subsidizing a tax break for mega millionaires.

May 2, 2021 - 8:06pm

Carry used be cap gains. Now will be ordinary income. Doesn't matter though because cap gains is going to be ordinary income in general (few exceptions TBD in senate). Part of it is a talking point, part of it makes sense.

May 3, 2021 - 3:41pm

The big point missed here is home sales are cap gains for regular americans. 

it's total income >1 mil and you get lumped into the new rule. Gains from sale of a home will be included in that sum. It's basically fucking over top ~5% of Americans. Makes sense. They have the least political sway and no one feels sorry for them. 

May 3, 2021 - 7:08pm

Taxes go up and down. Maybe Buffett said when he started out the corporate tax rate was maybe over 50%. The people who are not able to afford paying more in taxes will hopefully find a way to restructure their taxable income so they can pay all the taxes they owe

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