Profit-sharing legislation: ready, shoot, aim

Will Rogers said, “I’m not kidding. I just watch the government and report the facts.”

No jokes today, just some government facts.

Good stories have a villain. There are plenty. In my youth, it was Snidely Whiplash, the cad who tied his girlfriend, Nell Fenwick, to the train tracks. Thanks to Canadian Constable Dudley Do-Right for saving the day.

In modern times, it is the hedge fund manager. Private equity fund manager and venture capital fund manager are also eligible.

These people receive what is called a “carried interest”. This involves them exchanging a stake for future profits. Sort of like the guy at the craps table who leaves his winnings on the pass line.

What’s wrong with that? Well, for one thing, there really aren’t any stocks being traded for profits. Instead, the manager is rewarded for investment services rendered during the life of the fund.

Again, what’s wrong with that? Well, the fund manager wants to benefit from favorable tax treatment for these rewards. Instead of ordinary tax rates, capital gains rates apply. That’s about 50% off fares.

There is definitely an inequity here. The problem is how to solve it. The tax result is a natural application of long-standing partnership tax rules.

To solve the problem, these long-established rules would have to be changed. If only we had a strong and honorable Canadian RCMP to do this.

Canadian constables are not authorized to draft US tax legislation. I checked this and found it to be true. So we have to rely on Congress.

Congress made some minor changes to these deferred interest rules in the 2017 tax law. The Senate proposed more sweeping changes. Senate Bill 1598 amends the Partnership Tax Act.

This column has about 700 words. The proposed new section—it’s a section—creating equity of interest carried is 6,328 words.

The Congressional Research Service provides summary descriptions of bills. CRS says the proposed law would apply to private equity or hedge fund managers.

The bill actually applies to carried interest received in partnerships that invest in “specified assets”.

It is important to define who or what you are talking about. If the parties are not on the same page, one or more of them may be unnecessarily injured.

In the great Pink Panther film series, starring Peter Sellers as the clumsy French Inspector Clouseau, many miscommunications occur.

Inspector Clouseau, disguised as a professor, enters a hotel and asks the clerk for a “reum”. The confusion caused by Clouseau’s accent led to an immediate problem. But it got worse.

Seeing a dog on the ground, Clouseau asks: “Does your dueg bite?” The clerk answered “no”. Clouseau then bends down and, holding out his hand, is promptly bitten.

“I thought you said your dueg didn’t bite!” It’s not my dog, replied the clerk. Obviously the wrong question was asked.

The right question to ask with carried interest is who we as a society want to subject to complex new laws to achieve a fairer tax outcome.

The Senate bill includes real estate rentals or investments as “specified assets.” So while the CRS explanation notes the application to hedge fund and private equity managers, the legislation is broader.

There are hedge fund managers who earn nine figures a year (i.e. hundreds of millions). Anyone in this atmosphere can hire the few experts who can understand a 6,328-word section of code.

I support fairer treatment of carried interest for those living in the capital gains penthouse. I work with a lot of real estate investors who have also carried interests, but who occupy (relatively) the basement. We have many tax laws that only apply to “large” taxpayers. New plans include corporate tax increases for those making $1 billion or more in profits. Other provisions apply to those with $25 million or more in gross receipts.

The issue of carried interest has remained in the crosshairs of tax lawmakers due to the large profits made by hedge fund and private equity managers.

We should ask ourselves, does your hedge fund manager bite? Let’s muzzle those who do. The real estate guys I see are not those managers.

Jim Hamill is the Tax Practice Manager at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected]

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