Obama FY 2012 Budget Proposal Again Targets Carried Interests

Obama FY 2012 Budget Proposal Again Targets Carried Interests

On February 14, 2011, the Obama administration released its proposal for the FY 2012 budget. Several tax policy issues pursued by the Obama administration in previous years were again included in the budget proposal, including the taxation of “carried interests” as ordinary income.

The movement to tax “carried interests” as ordinary income made significant headway last year. In May 2010, the House passed legislation that would tax partnership allocations to fund managers (and other non-capital contributing service providers) at ordinary income rates as opposed to the preferential capital gains rates enjoyed under current law. That legislation was never approved by the Senate, but Senator Baucus proposed a modified version of the bill in September 2010. The 2010 modification proposed by Senator Baucus has been the subject of heavy criticism, as commentators believe the metaphorical net cast by Congress would capture many more taxpayers than intended.  It wouldn’t be the first time.

Generally, the legislation proposed by Senator Baucus would tax a percentage of the gain attributable to “investment service partnership interests” (or ISPIs) at ordinary rates. The problem is that the proposed legislation defines ISPIs broadly and offers few exceptions for relief. When considering partnerships with related parties and tiered partnerships it becomes clear that a single service provider can quickly turn the partnership interests held by many other legitimate, capital contributing partners, into ISPIs taxed at ordinary rates. The proposed rules also require taxation of direct and indirect dispositions of ISPIs, regardless of whether another section of the Internal Revenue Code would preclude or defer taxation. The proposed legislation offers exceptions for holders of “qualified capital” and partnerships with strictly pro-rata allocations, however, commentators find little solace in these exceptions.

The FY 2012 budget proposal is a sign that the Obama administration intends to again push the ordinary income taxation of “carried interests”. Whether that will be pursued under the Senator Baucus proposal or another is yet to be determined.

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Roger Royse
rroyse@rroyselaw.com

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City.
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