United States: Trump Era Tax Reform: Implications For Private Equity

Although decades have passed since the U.S. tax system's last overhaul, the combination of a Republican-controlled Congress and Donald Trump's victory in the presidential election suggests that comprehensive tax reform is on the horizon. Such reform could have substantial effects on the private equity industry. When asked during a presidential debate to identify specific tax provisions he would change during his term, President Trump replied that he would end the current capital gains tax treatment of carried interest¹, a move that could result in changes to how fund managers structure their fees.

In addition to President Trump's stance on carried interest, he and Republican lawmakers alike have plans to reduce the corporate income tax rate. The elimination of carried interest's preferential tax treatment, along with the lowering of corporate income tax rates, could reduce the disparity between the income tax treatment of limited partnerships and corporations.

Carried Interest

As a general matter, much of the income of private equity funds is related to the sale of securities held for investment, which generally is characterized as long-term capital gain. To capture the benefit of the preferential rate on capital gains, the general partner usually receives its economic benefit in the form of a carried interest—typically a fixed percentage share of the partnership's profits above a certain threshold. To ensure that the capital gains treatment passes through to the fund's other service providers, the general partner, commonly structured as a limited liability company, then issues interests in the company to such other service providers.

In recent years, lawmakers have introduced various proposals that, if adopted, would tax all or a portion of the service element of carried interest as ordinary income.² These proposals vary in their approaches. For example, the Carried Interest Fairness Act of 2015, introduced by Rep. Sander Levin (D-MI), sought to recharacterize income allocable to an "investment services partnership interest" as ordinary income.³ Taking a different approach, the Tax Reform Act of 2014, introduced by former chairman of the House Ways and Means Committee Rep. Dave Camp (R-MI), sought to reduce the top income tax rate from 39.6 percent to 25 percent, and add a 10 percentage point surcharge for carried interest.⁴

Predicting how President Trump may go about changing the treatment of carried interest is no easy task. Despite President Trump's reported stance on the issue, the House Republicans' current tax reform plan contemplates no such change.⁵ Some have suggested that the administration could act without involving Congress to change the tax treatment of carried interest.⁶ The legality of any such action is outside the scope of this article.

Corporate Tax Rate

The prospects of lowering of the corporate tax rate seem clearer, as Republican lawmakers and President Trump share that general goal, albeit with different target rates in mind. In a recent meeting with senior executives of some of the nation's largest companies, the President communicated his desire to reduce the corporate income tax rate from 35 percent to anywhere from 15 to 10 percent.⁷ The House Republicans' tax reform plan seeks a 20 percent corporate income tax rate.⁸ These proposed reductions in corporation income tax rate coupled with President Trump's reported stance on carried interest make the adoption of tax reform measures that narrow the tax efficiency gap between limited partnerships and corporations a possibility.

Conclusion

When it comes to the specific effects of the Trump administration on the private equity industry, speculation abounds. Although President Trump has expressed his desire to end the current capital gains tax treatment of carried interest, the House Republicans' current tax reform plan does not address the subject. In addition, President Trump and House Republicans currently disagree on the amount of the decrease in the corporate tax rate. Despite this lack of certainty, the possibility for tax policy to go in a significantly different direction is a real one, and we will continue to examine the implications.

Footnotes

1. Dan Primack, Presidential Debate: What is Carried Interest, Fortune (Oct. 10, 2016), http://fortune.com/2016/10/10/presidential-debate-what-is-carried-interest/.

2. Andrew W. Needham, Tax Management Portfolios, U.S. Income, Private Equity Funds A-30 (275-3rd 2015).

3. H.R. 2889, 114th Cong. (2015).

4. William Alden, House Proposal Would Raise Taxes on Private Equity Income, Dealb%k, New York Times (February 6, 2014), https://dealbook.nytimes.com/2014/02/26/house-proposal-would-raise-taxes-on-private-equity-income/.

5. Lynnley Browning, Carried Interest, Quicktake, Bloomberg (January 18, 2017), https://www.bloomberg.com/quicktake/carried-interest.

6. Sahil Kapur, Here's How Trump Could Try to Kill Carried-Interest Tax Break, Quicktake, Bloomberg (January 17, 2017), https://www.bloomberg.com/politics/articles/2017-01-17/here-s-how-trump-could-try-to-kill-carried-interest-tax-break.

7. Bourree Lam, Trump's Promises to Corporation Leaders: Lower Taxes and Fewer Regulations, The Atlantic (Jan. 23, 2017), https://www.theatlantic.com/business/archive/2017/01/trump-corporate-tax-cut/514148/.

8. H. Committee on Ways and Means Republicans, A Better Way: Our Vision for a Confident America (2016), https://waysandmeans.house.gov/taxreform/.

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