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Private equity: Not out of the woods with carried interest yet

There was a moment last month when it seemed like lawmakers were poised to pass a major tax hike on the earnings of some of the country's wealthiest financiers at private equity and venture capital firms, who critics say are benefiting from a giant tax break for Wall Street. But the measure was buried in the jobs bill, which Democrats struggled to pass because of concerns over spending. And then things went quiet.

But the private equity industry isn't out of the woods yet. Carried interest is the cut investment partnerships make off the appreciation of their clients' portfolios. The controversy over how to tax this money -- which is treated as capital gains, even though critics say it should be taxed at the higher ordinary income rate -- could come back.

Here's where things stand now:

Democrats have decided to split the carried interest issue from the jobs benefits bill, so if lawmakers go after the issue again, they'll likely put it in a new tax extenders bill, which would tackle a handful of other tax issues too.

These other measures, such as renewing research and development tax credits and imposing new rules on taxing multinationals, get mixed reviews from big business. On the one hand, large tech multinationals like Intel are eager to see Congress renew r&d tax credits, which have already expired. On the other, some big companies are worried about paying more taxes on money earned overseas.

If business is ambivalent about this bill, as one industry lobbyist explained to me, there could be less urgency about getting it off the ground.

Now even if carried interest does make a return in an extenders bill, there's still some unfinished business.

Democrats have to win the support of moderate Republicans for the blended rate solution they've proposed for taxing carried interest, with 75 percent of the proceeds taxed as ordinary income, which is higher than capital gains, beginning in 2011. Additionally, anything held for more than five years would be taxed as 50 percent capital gains and 50 percent ordinary income.

And moderate Republicans are unlikely to be happy about another tax hike in the bill, this one on sales of private equity partnerships. When debate over the jobs bill was in full swing, industry lobbyists seemed to be getting some sympathy from a couple moderate Democrats, and they're likely to get even more from Republicans should the tax come up again.

For three years lawmakers have failed in their attempts to raise taxes on carried interest. This time, there's plenty of public anger at Wall Street. Yet this fight could still go either way.

By Jia Lynn Yang  |  July 19, 2010; 3:21 PM ET
Categories:  Carried interest  
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