The big picture: This could become a full-time act for private equity accountants. What you need to know: We don’t yet have the full legislative text of Manchin’s bill, with Senate Democrats providing only a one-page summary. However, multiple sources say that the porting change will be removed from the House version of Build Back Better (RIP).
This does not reclassify carried interest as ordinary income, which everyone agrees would be the cleanest way to close the loophole (even among those who bristle at the suggestion that it’s a loophole). Instead, it focuses on retention periods. First, by extending the minimum holding period for capital gains treatment of carried interest from three years to five years. Second, by starting the clock on the later of the date the fund acquired “substantially all” of its deemed interest or the date it acquired “substantially all” of its assets.
Here’s the problem, as law firm Gibson Dunn explains: “The law does not specify how the ‘substantially all’ requirement is intended to be measured, and because many investment funds (eg hedge funds and private equity funds) acquire assets in different times and overlapping periods of possession, it would be extremely difficult for taxpayers to determine when these requirements are met.”
Beyond that, the language also creates perverse incentives for PE investors by creating different minimum holding times for different holding companies within the same fund. House Democrats were said to be working to fix the BBB language until Manchin and Sen. Kyrsten Sinema torpedoed the entire package. But nothing was ever coded, so the new design is the same as the old one. “Congress needs to provide more guidance on what fund managers intend to pay,” one private equity lawyer tells me. “Otherwise you get a free for all because no one can really understand this.”
Wildcard: It’s still very possible that Sinema will again refuse to play ball or insist on scrapping tax provisions like carryover and corporate minimums. Axios’ Alayna Treene last night reported more on her thinking.
The American Investment Council, a PE lobby group, notes that there are nearly 150 private equity firms based in Arizona, plus 678 PE-backed holding companies that employ 229,000 Arizonans.
Savings: Senate Democrats claim transfer tax changes could bring in $14 billion over 10 years. Quite impressive. Not the number, per se, but that everyone felt comfortable calculating a number given the legislative ambiguity.
It’s also worth noting that $14 billion is the same amount CBO used in 2019 for a proposal that would count the carryover as ordinary income. Certainly the near-term outlook for polyethylene earnings was a bit stronger in 2019 than in 2022…
The bottom line: The political debate over taxing carried interest began more than a decade ago. It’s no less messy today than it was back then.