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Here’s How Trump Could Try to Kill Carried-Interest Tax Break

Here’s How Trump Could Try to Kill Carried-Interest Tax Break

(Bloomberg)—President-elect Donald Trump railed against his main political opponent for allowing a tax break that lets some investment managers pay lower tax rates than average workers. After he takes office, he may have no one to blame but himself.

Some tax law experts say Trump could unilaterally end the so-called “carried interest” loophole, which enables fund managers to pay a tax rate as low as 20 percent -- roughly half the top rate for ordinary income.

Republican lawmakers have shown little desire to change it. But Trump could act without going through Congress because there’s no official statutory definition for carried interest, according to Roberton Williams, an economist with the Urban-Brookings Tax Policy Center. “It’s defined by IRS regulation,” Williams said. “And they could redefine it.”

Carried interest is the portion of a fund’s profit -- usually a 20 percent share -- that’s paid to private equity managers, venture capitalists, hedge fund managers and certain real estate investors. Currently, tax authorities treat that income as capital gains, making it eligible for the lower rate. The top tax rate for ordinary income is 39.6 percent.

Trump highlighted the carried-interest tax break during his populist presidential campaign, labeling some hedge fund managers “paper pushers” who are “getting away with murder.” During his second debate against Democratic nominee Hillary Clinton, he criticized her for failing to abolish it during her years in the U.S. Senate. Clinton had previously said that, as president, she’d ask the Treasury Department to use its authority to end the carried interest loophole. Trump’s plans remain unclear.

The president-elect’s transition team didn’t return two e-mail messages seeking comment. Tara Bradshaw, a spokeswoman for Trump’s nominee to lead the Treasury Department, Steven Mnuchin, didn’t respond to an e-mailed request for comment.

Trump Blueprint

The carried-interest tax break dates to the 1920s, when Congress first set up a preferential rate intended for the sale of capital assets such as farms and mineral properties, according to a 2013 paper by Steven M. Rosenthal, a senior fellow at the nonpartisan Tax Policy Center. Over time, many prominent investment bankers sought to take advantage of that rate, and the IRS accepted their arguments -- a move that Rosenthal argues “drifted away from Congress’s original statutory framework for capital assets.”

If Trump acted to change the regulatory definition, he might face legal challenges from entities affected, who’d argue that he exceeded his executive authority, experts said. Opponents might be found in the $2.5 trillion private equity industry, which has previously lobbied against changes to the tax treatment of carried interest. Billionaire Wilbur Ross, who made his fortune in private equity, is Trump’s nominee for Commerce secretary. Jamie Hennigan, a spokesman for Ross, directed a request for comment to the Trump transition team.

“The tax treatment of carried interest capital gains is sound tax policy which encourages the U.S. tradition of entrepreneurial risk taking," said James Maloney, a spokesman for the American Investment Council, which lobbies for the private equity industry. He argued that amending carried interest would require statutory changes.

An economic blueprint Trump released in September says the president-elect would end the carried-interest loophole for Wall Street. The next month, Ross said during a Washington tax conference that he expected to pay higher taxes under Trump’s proposal. In describing Trump’s plan, which would provide a menu of rate cuts for individuals and businesses, Ross said: “The intent, clearly, is that no taxpayer -- other than those with carried interest -- will be disadvantaged.”

GOP Pushback?

So far, congressional Republicans, generally opposed to higher taxes, haven’t gone after carried interest. A tax overhaul plan released by House Speaker Paul Ryan in June doesn’t mention the tax break. Many Republican members of the House Ways and Means Committee are pushing not to change the treatment of carried interest in an overhaul of the tax code, but Committee Chairman Kevin Brady, a Texas Republican, told Bloomberg BNA last week that no final decisions have been made yet.

It’s not clear whether a unilateral move by Trump would be supported by Republicans. Representative Bill Flores of Texas said in an interview changing the carried-interest break “has to require authorization from Congress.” Representative Peter King of New York said he’s “leaning” toward supporting Trump’s call for ending the loophole, but didn’t take a position on whether it could be done by executive action.

The Congressional Budget Office estimated in 2013 that taxing carried interest as ordinary income would raise federal revenue by $17.4 billion over a decade. Victor Fleischer, a law professor at the University of San Diego and co-chief tax counsel for Democrats on the Senate Finance Committee, has said that’s a low estimate and taxing carried interest at ordinary rates could actually raise $180 billion over 10 years.

Franken Measure

Addressing carried interest may be one of the few areas Trump and congressional Democrats agree on during the next administration. Senator Al Franken of Minnesota along with four other Democrats introduced a budget measure last week calling for ending the loophole.

Trump “should push to do it,” said Representative Jerry Nadler, a New York Democrat. “The carried-interest loophole is an egregious loophole that has no justification at all.”

Then why isn’t it gone already? President Barack Obama also decried the break, but he never took the bold step of changing it via executive order. Jared Bernstein, an economist who used to work in the White House under the current president, said it “wasn’t something that we fought particularly hard for because the politics just weren’t there.”

Now the politics have shifted, he said, but the tax break still has "a bench of defenders no matter how obscure or how wasteful it is."

--With assistance from Laura Davison, Melissa Mittelman, Saleha Mohsin and Erik Wasson. To contact the reporter on this story: Sahil Kapur in Washington at [email protected] To contact the editors responsible for this story: Alexis Leondis at [email protected] John Voskuhl

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