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On May 20, Democratic House and Senate tax writers released a tax extenders package (H.R. 4213) that includes provisions relating to the taxation of carried interest received by investment fund managers.
In general, the proposal would tax carried interest (and gain on the disposition of carried interest partnership interests) as ordinary income and as income subject to self-employment taxes. We described the previous version of the carried interest proposal in a client memorandum dated April 13, 2009, Update on "Carried Interest" Legislation: New Levin Bill and in a client memorandum dated December 9, 2009, House to Consider Bill Containing Carried Interest Proposal, Ban on Bearer Bonds and Updated FATCA Rules.
The new version is substantially similar to the version originally proposed by Rep. Levin and passed by the House in December, with the following changes.
- The most significant change is that, in the case of partners who are individuals, ordinary income treatment and self-employment tax would apply to only 75% of each item of income comprising the carried interest. For taxable years beginning before 2013, the percentage would be 50% instead of 75%.
- The new version would generally apply to taxable years ending after the date of enactment, which therefore would include calendar year 2010 if the bill were enacted this year. Pursuant to a special provision, however, the new rules would apply only to partnership income for the post-enactment portion of the year (or, if less, partnership income for the entire enactment year). In the case of disposition gains, the new proposal would apply only to transactions occurring after the date of enactment.
- The new version would clarify that gains attributable to a general partner’s own out-of-pocket cash contributions are eligible for capital gain treatment even though those contributions are not subject to management fees or carried interest (and thus are not pari passu with limited partner interests).
- The new version includes various other technical changes. Among other things, these changes would:
- Exclude the disposition of a publicly traded partnership interest by an individual who does not provide investment management services.
- Exclude the contribution of a carried interest partnership interest to an upper-tier partnership if the contributing partner elects to treat the upper-tier partnership as an investment services partnership interest.
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