Billionaire presidential candidate Donald Trump has been saying for weeks that he thinks hedge fund managers are getting away with “murder” under the current tax code.
But by the looks of his tax reform proposal released Monday, which left many questions unanswered, it’s possible they might still get a sweet deal.
At issue is what’s known as carried interest — or a portion of investment profits that is paid to managers of hedge funds, venture capital funds, and other private equity funds.
Currently those profits are taxed as capital gains at 20% (or 23.8% once you include a Medicare tax). In either case, that is well below the 39.6% top rate individuals pay now on ordinary income.
Trump, like Democrats and some Republicans before him, wants to change that. Trump never says so specifically, but the assumption has been that he would tax carried interest as ordinary income, not capital gains.
At the same time, however, he also wants to slash the top rate on ordinary income nearly in half — to 25% from 39.6%.
In that scenario, hedge fund managers would only pay 25% on their carried interest income, up just 1.2 percentage points from the 23.8% they pay today.
There’s another scenario in which hedge fund managers potentially could pay less than they do today. It would involve them restructuring how they are paid, said Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center.
Currently, in addition to their carried interest, managers of hedge funds earn a fee equal to 2% of assets under management. Under today’s code that 2% is taxed as ordinary income.
Hedge funds can be organized as small business partnerships. So they could benefit from a separate proposal in Trump’s tax plan to lower the tax rate on small business partners to 15%.
Conceivably a hedge fund could raise the management-fee portion of fund managers’ compensation, and lower or eliminate the carried interest, so more of their income would be taxed at 15%, Rosenthal said.
Another thing that remains unclear: Would Trump’s proposal affect only hedge fund managers or other types of fund managers as well? He simply says it would apply to “speculative partnerships that do not grow businesses or create jobs and are not risking their own capital.” Americans for Tax Reform, the conservative tax group run by Grover Norquist, is reading that to mean Trump would exempt private equity firms.
If that interpretation is correct, then Trump misses the mark.
“In recent years, private equity managers benefited [from carried interest]. But not many hedge fund managers,” Rosenthal said.
How much additional revenue Trump’s proposed carried interest change would bring in is a mystery. Chances are it would be considerably less than the $ 17.7 billion that Treasury estimates would be raised over 10 years if investment managers had to pay a 39.6% rate on their carried interest.