'Carried interest' considered.

On June 22, House Democrats introduced legislation (HR 2834) that would alter the tax treatment of "carried interest" received by managers of investment partnerships. The measure would tax carried interest as ordinary income (at rates up to 35 percent) instead of as long-term capital gains (at rates up to 15 percent).

To the extent that a manager's income represents a reasonable return on capital actually invested in the partnership, however, the 15 percent capital gains rate would continue to apply.

The Senate is considering a much narrower bill (S 1624) that does not specifically address the taxation of carried interest. However, the Senate Finance Committee continues to examine the broader issue of "carried interest." It held the first of two planned hearings on the issue July 11 and is expected to introduce "carried interest" legislation later this year.

Tax policymakers said the bill is intended to address inequities in the taxes being paid by private equity funds and their managers, although opponents say it is largely designed to raise revenue to pay for other legislation, including Alternative Minimum Tax relief for the middle class.

The House legislation as currently drafted is quite broad and would apply to public and private partnerships that invest in securities, commodities and real estate. NAA/NMHC oppose the House measure and are working to educate Congress on the unintended consequences such a tax change could have on legitimate transactions and arrangements.

So far, reaction from the Bush Administration has been extremely wary of changes in the area, with Treasury Secretary Henry M. Paulson warning of "unintended consequences" of tax modifications that are not well thought out. The recent Senate hearing made it clear that there is little consensus among members of the Finance Committee on what changes, if any, should be made to the taxation of carried interests. NAA/NMHC's discussions on Capitol Hill suggest that many lawmakers are still developing their opinions on what they believe the appropriate tax treatment should be for carried interest, and several alternatives, including doing nothing, are on the table.