The “carried interest” tax break is once again the subject of a fierce debate, and business owners could feel the effects of its outcome.
The $3.5 trillion budget reconciliation bill, which is still in the works in Congress, could target carried interest, which is a common way for venture capital investors, private equity partners, and hedge fund managers to receive compensation. It allows for such investors or managers to share in the profits of their funds at a reduced tax rate. Those profits are now taxed at the long-term, top capital gains rate of 20 percent plus a 3.8 percent net investment income tax, rather than as ordinary income, which is subject to a top rate of 37 percent.
President Biden along with many Congressional lawmakers have called for eliminating the carried interest tax break in the budget deal. General partners and investors would still make profits from their ventures, but they would be taxed at a much higher rate. Doing so could generate $16 billion over 10 years, according to a Joint Committee on Taxation estimate.
In a statement, Senate Finance Committee Chair Ron Wyden (D-OR) called the benefit “one of the most indefensible loopholes in the tax code.”
Those who support maintaining the status quo argue it’s a fair tax break considering the high-risk nature of entrepreneurial investing. Ending the tax break, they say, would divert money from startups and other job-creating investments.
On Tuesday, the U.S. Chamber of Commerce, a business advocacy organization, released a study arguing one of Biden’s proposed changes to the tax would force affected industries such as real estate investment and private equity to downsize, cutting 4.9 million jobs, hurting pension returns, and unfairly sanctioning industries that invest in sectors including sustainability and healthcare.
“The impact… would be broadly felt across the economy because of the chilling effect it will have on investment activity,” the organization wrote in a press release.
Some of the Chamber’s survey assumptions are a little “far out,” according to Jeffrey Sohl, professor of entrepreneurship and decision sciences at New Haven University.
“If this goes into effect, is the venture capital industry going to cease to exist? I don’t think so,” Sohl says.
Removing or altering carried interest has been a topic of discussion among lawmakers at least since the time of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed in the wake of the 2008 financial crisis, Sohl adds. With Democrats in control of the reconciliation process, it’s likely carried interest will take a hit, even if it provides carve-outs for things like impact investing.
But the possibility of a drastic change has some investors anxious. Mac Conwell, who runs Baltimore-based RareBreed Ventures, says the loss of carried interest would slow his relatively new firm’s growth. A lot of the profit he gets from carried interest goes right back into the fund, he says, so it would limit the number of startups the venture could help.
Further, he worries the tax would simply mean less money for founders, making venture funding even less equitable. “The founders who are going to hit hardest are underrepresented,” he says.
Small investment firms like Conwell’s are forgotten in political debates over this tax increase, says Brett Palmer, president of the Small Business Investor Alliance (SBIA), a trade association of private equity and venture funds. By the logic that smaller investment firms are going to invest in smaller businesses, less money for these firms means less investment in small- and medium-size businesses, he says.
Sohl agrees a change to the law wouldn’t mean as much to the larger players. “The first funds hit by this are not going to be the Andreessen Horowitzes,” he says.
There are a slew of other tax changes under consideration as part of the budget reconciliation bill, including some for pass-through businesses. The bill could be passed without Republican support but would require a near-unified front from Democrats.
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