Interesting piece by John Steel Gordon in today’s WSJ:
One of the artifacts of the tax code is that it treats “carried interest”—a share of the profits reaped by managers of an investment fund—as a capital gain. To most of us, this is a matter of little or no practical importance—but it is a big deal indeed for the managers of many private equity funds and some hedge funds.
Managers of these funds are compensated for their services in two ways. One is the annual management fee, usually 1% or 2% of a client’s investment. The other is a share in the net profits of the fund’s long-term investments. That share is often 30% or even more.
The management fee is taxed as ordinary income, but the long-term profits of investment are taxed as a long-term capital gain, for both clients and hedge-fund managers.
There is no doubt that the profits are true capital gains for the clients of these funds. They risk their money and hold the investment over time; if it loses money they experience a capital loss. Not so for the managers of these funds, who share in the gains but not the losses. They do not put their own money at risk; the reality is that the compensation for their services is income and should be taxed as such. (Of course when fund managers invest their own money their profits should be taxed as a capital gain.)
“Carried interest” SHOULD be taxed as ordinary income.
I dream of the day when we can toss out this stupid tax code we currently have and bring in a flat tax. It’ll never happen but I can still dream about it.