18 Comments
Jul 28, 2022Liked by Jeffrey Carter

The argument is that venture capitalists and private-equity partners who get paid off the ‘carry’ are really being paid for their labor, since it reflects the work done by the VC on behalf of the investors….and that hence, it should be taxed at ordinary income rates.

BUT…when people are taxed on ordinary income, that usually represents the compensation for labor they have performed in the current tax year and were paid for when it was performed, or shortly thereafter. Whereas the work a VC does on a deal is mostly front-end-loaded….he may spend a lot of time reviewing & filtering a range of possible deals, finally selecting a relative few of them, and then spend additional time structuring the deals. And the payback will very often be 5 years or more in the future. So he’s doing work that he won’t be compensated for for many years, if ever.

Rather different in timing from typical hourly or salaried work; looked at in that light, the carried-interest CG treatment seems reasonable.

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Jul 28, 2022·edited Jul 28, 2022Liked by Jeffrey Carter

The VC is getting a 2% management fee on assets under management. That is ordinary income and taxed as such.

The "carried interest" is the product of success or failure which is determined by the management of risk. It is perfectly in alignment with how the fund and the VC perform. It is not ordinary income; it is capital gain and taxed as such -- appropriately.

VC probably comes in for a bit of extra scrutiny as they are not actually operating businesses, but real estate developers, oil drillers are all running huge operating risks and should be rewarded with equity style treatment.

Operators who invest and take risk should be treated as well or better than somebody on a computer buying 100 shares of XOM and holding it for a year -- no?

I always said Joe Manchin would roll over. Predicted it.

JLM

www.themusingsofthebigredcar.com

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usually 2% to 2.5%. I have seen rare occasions where the management fee is higher but those VCs have been unusually successful.

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I knew that. I modified my comment. Thanks.

We are truly doing all the wrong things.

JLM

www.themusingsofthebigredcar.com

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A bunch of morons running the show. If they applied for a job at your business and you mistakenly hired them, they'd be gone in a week. They'd sue you for something after you fired them, increasing the costs of employment. I always said if these idiots were on the trading floor we'd have eaten them for breakfast and shit them out by lunch. Most of them were born on first, second, or third base and didn't realize it wasn't their brainpower that got them there.

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I'd push back a little bit. The cap gains rate is designed to incent risk-taking with one's own capital. Yes, the GPs have to have some of their own funds in the deals they put together but the vast majority of the equity they are putting into deals belongs to the LPs and is nowhere near their 20% share of the carried interest. I have a real hard time defending cap gains rates for risk-taking with the capital of others. I'm not militantly against it but if you're going to raise taxes, I'd much rather see revocation of the CI benefit before raising corporate or ordinary income rates.

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My argument is that while they are not putting capital (in the form of money) into the deal, they are indeed putting capital (in the form of work, ie, sweat-equity) into it...and, unlike normal pay-for-labor work, they are not getting compensated for it for (typically) years.

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Which I think Jeff responded to in his comment about 2% management fees charged for ongoing work. That’s the whole point of them and why they are recouped when carried interest is paid out.

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Jul 29, 2022Liked by Jeffrey Carter

But I don't think very many people would want to run VC funds if their only compensation was the 2% management fee...the 20% is also part of the comp for the work they are doing, and I argue that the delayed nature of the payout makes cap gains treatment appropriate.

It's certainly not the most important tax-code item from the standpoint of supporting entrepreneurship....I'd be much more concerned about any attempts to raise the cap gain % rates or to eliminated/restrict the use of Qualified Small Business Stock....but I do believe, after thinking about it a while, that the carried-interest provision should be left alone. Somebody at twitter said something along the lines of 'only affects a few thousand very wealthy people', which (a) isn't true...I know someone starting a fund who is far from 'very wealthy' and (b) morally repugnant...would there being only a small number of people in a category allow the majority to do anything they want to them?

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Agree. Every fund is different in its set up docs but there are generalities. Basically, here is how the math works. Suppose you have a $10MM fund and invest over five years with a 2% mgmt fee and 20% carry. You get $200k a year to run the fund (accounting, audit, legal, salary, office expense etc) for a total $1MM over five years. Lots of funds "recycle" that, meaning they can invest the full 10MM. You invest in 10 companies, $1MM each. 50% fail. 40% return 1x-4x. Assume that return is $4MM so your mgmt fee is covered (2x on 2). That leaves 1 and you hope it goes 30x. So, 30MM-10MM invested=20MM. Limited partners get 80% of that=$16MM. GPs get $4MM. Also assume exits of that magnitude take 7-15 years. If you assume 11 yr average it works out to around $363K per year, plus your management fee....not peanuts but not "rich". Most GPs will have to put their own money to work in the fund as well, so it magnifies the risk on the GP.

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True. Commodity trading is different as well. It's marked to market at Dec 31 and you owe the full value of tax no matter if you have exited the position or not-and the tax is blended 60/40 cap gains and your income rate (works out to about 24%)

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From a business acquaintance, "Like Trump's tax bill before it, which was rushed through in reconciliation without a single Dem vote, this is a disaster of poor drafting, lack of clear policy and language bordering on the incomprehensible. The Democrats followed the lead of the OECD and put in a tax computes by reference to financial statement income. But unlike Europe where tax is computed by reference to financial statement income the US doesn’t do that and haven’t done it for 100 years. It will make money for the accounting firms but won’t grow the economy."

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Manchin was playing McConnell like the failed idiot he is. Just pass gun control and we will like you , just pass Chips and we will like you. Then spit in his face and laugh at him. The rinos always surrender !! ALWAYS.

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Yeah carried interest is a tough loophole

So you let PE go out rape and pillage mostly good business Then don’t pay taxes on all short term and long term gains indefinitely

I’ve seen to many good family bussiness es destroyed by PE

Then you get a 176 page closing document

Which comes down to who has the better attorney or judge 😉

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The families sold their businessess....they got paid and the check cleared. Not all PE things work out for lots of reasons. I wouldn't blame the whole sector.

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I was witness to more than just a few

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Imagine the work-around that someone dreams up... With the capital gain allocated to the GP now taxed at the ordinary income rate--in other words a gain is no longer a gain, but income--what adjustments will the partnership make?

Why let a gain be taxed as income--adjust the allocation so that the limited partners get the cap gain, and the GP takes income taxed as income. Why let the govt rape your partnership?

Since the type of assets invested vary between hedge, venture, private equity, and real estate, there will be some variation as between income, expense, gains, and losses, and an opportunity to shift allocations. In some cases, it will be obvious, in other perhaps not worth the extra complexity.

I'd be curious to see the assumptions for the tax revenue estimates produced for this legislation.

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