Once again the “carried interest” tax (affecting alternative asset managers almost exclusively) has come to the forefront of the tax discussion and debate. To illustrate how this works, here is an example: A Private Equity General Partner/Manager traditionally puts up its own cash commitment to a fund (let’s say $20 million for purposes of this example). The Manager/General Partner seeks investors or limited partners and let’s say they put up $500 million in commitments. On the sale of an individual investment within the?Fund (let’s say representing $100 million of capital), after proportionate expenses are returned and an at least 8% annual return is met, the General Partner will get a disportionate share of the profits (20% of the Limited Partner’s profit typically).

Traditionally this “carried interest” has been taxed how ever the overall gains are taxed (typically long-term capital gains and therefore 15% today). The proposed legislation treats these amounts as ordinary income or compensation and essentially raises the rate to 39.6% (the proposed highest tax bracket). Private equity is responsible for the growth and building of thousands of businesses and the “carried interest” is seen and should be seen as additional investment income. The fundamental change to that concept (compensation from investment income) is not just harmful to the alternative asset community, but it is widely not supported by many of the largest pension funds as it changes the economics and prospects for attracting and retaining top talent to start and run firms.? Additionally, as was recently pointed out to me by somebody, the world could learn a lot from the Private Equity model.? No incentive compensation unless you meet the 8% preferred return hurdle.