This chart above shows how carried interest works.
The “Romney loophole” otherwise known as the carried interest rule has been a carve out in the tax code that allows private equity guys like Romney to pay only 15% in taxes on someone else’s capital gains (not their own) instead of paying the 35% marginal rate that every other millionaire has to pay. It is a specific loophole that only certain types of hedge fund managers and private equity financiers are able to take advantage of and Romney has a history of abusing this tax preference that Bain Capital lobbied for for years.
Romney is not supportive of eliminating the carried interest deduction because he and his donors have made hundreds of millions thanks to this government welfare. Obama has been working the past two years to eliminate that preference.
The Financial Times explains that private equity managers are now concerned about the elimination of the carried interest deduction due to the visibility of Mitt Romney’s campaign now that Americans are becoming aware of it HERE:
Carried interest is taxed at the 15 per cent rate for all capital gains but the Obama administration has proposed changes that would see carried interest charged at the same rate as income, typically 35 per cent.
Spurred by the possibility of a change in taxation, five LPs told the Financial Times that many GPs were introducing general clauses into partnership agreements that would give them power to change the terms if there was any change in the tax regime.
The clauses are usually general, giving reasons why partnership agreements can be changed without the consent of limited partners, rather than mentioning carried interest specifically.
In its offer memo before listing this year, Carlyle warned potential investors that if such taxes were implemented, the business might come up with arrangements to compensate its executives, with those arrangements then cutting into returns for investors.
Critics of the current tax, including the Obama administration, have moved in the past two years to change these rules by increasing the tax charged on the carried interest earned by these financial firms. Proposed as one of the many tax changes in the American Jobs Act, the new rule would tax profits from the sale of investment management partnerships at the top ordinary income rate of 35 percent.
Critics of the tax increase argued the higher rates are essentially a special tax on financial entrepreneurs. The current lower tax rate on capital gains applies to all industries, whereas the new one would single out private equity and venture capital firms and hedge funds for a heavier tax. They also say this tax increase is a politically motivated move against Wall Street, designed to demonize financial companies for an alleged role in the current recession.
For a detailed, unbiased run through of the carried interest deduction – you can read this HERE from the Tax Policy Center.
You can read more about the changes to the tax code that Obama is proposing in his 2013 budget; an excerpt HERE:
* PAYROLL TAX CUTS. Extending a cut in the worker share of the payroll tax through 2012. The payroll tax funds the Social Security pension program. Lawmakers are working on a deal to renew a two-month extension of the break for 160 million workers before a late February deadline.
* BUSH TAX CUTS. Ending tax cuts in 2013 that were enacted 10 years ago under President George W. Bush for households making more than $250,000 a year, but keeping the lower rates for those who earn less.
The issue must be dealt with by year-end, or taxes on nearly every American will rise. Dealing with this is likely to be postponed until after the November 2012 presidential election.
* CARRIED INTEREST. Forcing private equity managers and some others to pay the 35 percent ordinary income tax rate, instead of the 15 percent capital gains tax rate, on a big chunk of their annual earnings, known as “carried interest.”
* BUFFETT RULE. Slapping a new, minimum tax on millionaires, known as the “Buffett rule” after Warren Buffett, chairman of Berkshire Hathaway, who backs it. The rule would ensure people making more than $1 million a year pay at least a 30 percent effective tax rate.
* ITEMIZED DEDUCTIONS CAP. Obama had previously proposed limiting the value of itemized tax deductions and exemptions for individuals earning more than $200,000 a year and families earning more than $250,000. A cap would apply to popular deductions like mortgage interest and healthcare.
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