Tightening Carried-Interest Loophole May Not Choke Private-Equity Firms After All

An amendment late Monday to the tax bill winding its way through the U.S. House of Representatives appears to fulfill President Donald Trump's promise to close the so-called carried-interest loophole private-equity firms enjoy while also preserving many of the benefits they derive from it.

Since his days on the campaign trail, Mr. Trump has made repeated pledges to tax investment gains known as carried interest as ordinary income, which would do away with a rule allowing investment managers to pay a lower rate on a substantial portion of their compensation. Private-equity firms have pushed back, arguing that paying the lower long-term capital gains rate affords them an incentive to take investment risks that benefit the economy.

Monday's changes to the bill by House Ways and Means Committee Chairman Kevin Brady (R., Texas) would extend the period over which firms must hold an asset before it is eligible for the long-term capital gains rate, to three years from one. While that may hurt some hedge funds, private-equity firms, which tend to hold assets for longer, would be largely unaffected.

The top rate on long-term capital gains held more than a year is currently 20%, an amount that wouldn't change under the House bill. A 3.8% tax on net investment income also typically applies.

"I don't see this stopping private equity," said Andrew Kreisberg, a tax attorney with White & Case LLP. Republican lawmakers are "clearly sticking to their line of wanting to incentivize long-term investment."

The American Investment Council, the private-equity industry's main trade group in Washington, is still publicly opposed to any changes to the treatment of carried interest, arguing such a move "discourages investment and jeopardizes economic growth."

Privately, however, many industry participants are breathing a sigh of relief, as they doubt that the proposed extension of the holding requirement, from one year to three, would have much of an effect on firms' willingness to do deals.

Those deals, which typically involve taking on copious amounts of debt to buy companies and then selling them five or so years later, have proved enormously lucrative, with private-equity firms consistently notching double-digit annual investment gains.

Venture capital firms, which also tend to have a longer investment period, are also unlikely to be affected, law firm Akin Gump Strauss Hauer & Feld LLP said in a note to clients Tuesday.

There are some instances in which private-equity firms sell companies less than three years after buying them, of course, but those are usually the more successful deals; indeed, quick flips have become more common in recent years as asset prices have climbed to all-time highs.

The bigger concern for private equity remains the tax bill's proposal to limit businesses' ability to deduct interest, with a cap of 30% of earnings before interest, taxes, depreciation and amortization. Industry officials argue the proposal would threaten their business model, given how reliant on debt they are.

But other aspects of the House effort would benefit buyout shops, particularly a move to lower corporate tax rates.

The changes around carried interest would raise $1.2 billion in revenue over a decade, according to an estimate by the nonpartisan Joint Committee on Taxation.

That is less than a 2015 Democratic effort to reclassify all carried interest as ordinary income, which would have raised an estimated $15.6 billion.

--Richard Rubin contributed to this article.

Write to Miriam Gottfried at Miriam.Gottfried@wsj.com

(END) Dow Jones Newswires

November 08, 2017 05:44 ET (10:44 GMT)