PE professionals in the US will be relieved about the latest proposals on taxing their carried interest gains.

October 7, 2021

Those of you who read my July article on this subject may well be wondering what happened to the Biden administration’s budget proposals, which threatened to significantly increase the rate of tax private equity managers in the United States would be required to pay on their income and their capital gains.

Well, on 15th September, the US House Ways and Means Committee approved tax increase proposals which if enacted were estimated to raise c $2 trillion over ten years.

Amongst the main proposed tax increases, these included:

Increasing the top individual ordinary income tax rate to 39.6%, for taxable income over $450,000 or $400,000 for unmarried individuals- under Trump, the top rate of income tax was 37%;

Imposing a 3% high-income surcharge on income (both ordinary income and capital gains) above $5m;

Increasing the top long-term capital gains tax rate from 20% to 25%;

Increasing the corporate tax rate from 21% to 26.5% for entities with taxable income above $5m.

The Democrats say those increases will go a long way to funding President Biden’s ambitions to expand the federal government’s role in education, health care, climate change, paid leave and more.

What is interesting is that these proposals, whilst still quite aggressive, are quite a bit tamer than were proposed earlier.  Perhaps the most striking change from the Biden’s administration’s original proposals is the proposed new rate of capital gains tax.  Under the original proposals, it was suggested that “the carried interest tax rate” (i.e. the top capital gains tax rate) for individuals would be 39.6%, equivalent to the top proposed federal income tax rate.

Bringing this proposed rate down to only 25% is a big step down.

Another significant change is the reduction in the proposed corporation tax rate for larger companies to 26.5% – the original proposals suggested that this would go up to 28%.

It is apparent that the Democrats do not want to see another “noble defeat” in Congress for tax changes that would just simply be unthinkable to the majority of the House.  Facing the delicate politics of a narrowly divided Congress, senior House Democrats have opted to be more mindful of moderate concerns in their party than of its progressive ambitions. They have decided to focus on the old and better-established ways of raising revenue: by raising tax rates on income rather than targeting wealth itself.

A headline in a well known US newspaper said:

“House Democrats’ Plan to Tax the Rich Leaves Vast Fortunes Unscathed”

The measures now proposed dispense with suggestions once floated by the Biden administration to tax wealth or to close off loopholes that the very wealthy have managed to exploit to pass on their wealth to their heirs tax-free.

What is not clear though, is whether the Democrats really believe that they will get even these tax changes through.

Key Democrats cautioned that the House proposals were still likely to change — perhaps considerably — as Mr. Biden’s economic agenda progresses its way through the House and Senate, where Democrats hold the slimmest of majorities.  During this process, the Biden administration must hold nearly every member of their ideologically diverse party together.

But White House officials welcomed the Ways and Means plan and said it took important steps toward the President’s vision of a tax code that rewards ordinary workers at the expense of the very rich.

Whatever happens, it appears that private equity carried interest plan participants in the United States will be relieved.  The threat to tax their gains from carry at rates equivalent to income tax has seemingly gone.

Nonetheless, as noted above there is still some way to go yet.  But it does seem that the Democrats have a degree of confidence that these new proposals may actually pass into law.

And even if they do, it would remain the case that the rate of tax that US carry participants might have to pay on their carried interest gains (being at 25%) would still be lower than here in the UK, where carried interest gains are taxed at 28%.

Such an outcome would be welcome in the UK as it would be less likely to cause a rethink over here about whether carried interest gains should be taxed at ordinary income rates.

For further information contact Nigel Mills.

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