Tax Treatment of “Carried Interest”

ABSTRACT The term “carried interest” is typically used to refer to profits interests issued by investment partnerships to their manager(s). It is an ownership interest in a partnership that has no liquidation value at grant, but entitles the holder to a share in future partnership profits, if any. The term “carried interest” hails from the fact that the “carried interest” holder typically does not invest any of the holder's own capital in the partnership. Thus, the “carried interest” holder is “carried” by those who do invest capital in the partnership. Currently, the income that a “carried interest” receives is generally taxed as capital gain. Many commentators believe that income allocated by a partnership to “carried interest” holders should be taxed as compensation because the income is for the services the partner performs for the partnership. This paper will examine what the proper tax treatment of “carried interests” should be based on what is the most economically equitable, fair, and efficient method of taxation. Based on the equity and efficiency concepts, the authors suggest that a portion of all “carried interest” income should be taxed as a payment in exchange for services (i.e., as compensation)—regardless of the nature of the underlying assets inside the partnership and regardless of the nature of the business the partnership conducts. However, what qualifies as a “carried interest” and the portion of the income that should be taxed as compensation are not as easily defined.</jats:p

Congress Finally Passes Carried Interest Legislation, But is it Enough?

ABSTRACT After numerous failed previous attempts to enact legislation taxing “carried interest” income attributable to services as compensation income versus capital gains, Congress enacted Section 1061 as part of the Tax Cuts and Jobs Act. Unlike previous proposals, which would tax carried interest income attributable to services as compensation income, Section 1061 simply reclassifies some carried interest income attributable to services as short-term capital gain. By choosing to treat carried interest income attributable to services as short-term capital gain instead of as compensation income, Section 1061 exempts such income from self-employment tax and allows taxpayers to offset such income with an unlimited amount of short-term capital losses. This paper reviews the requirements under Section 1061 and explains several ambiguities created by the new law. In addition, this paper examines whether Section 1061 follows sound tax policy. The authors find that Section 1061 does not follow the tax policy concepts of equity and fairness, economic efficiency, neutrality, simplicity, or certainty. In addition, the authors find that Section 1061 will have minimal impact, as most carried interest is held longer than the required period to qualify as long-term capital gain.</jats:p

Congress finally passes carried interest legislation, but is it enough?

After numerous failed previous attempts to enact legislation taxing ‘‘carried interest’’ income attributable to services as compensation income versus capital gains, Congress enacted Section 1061 as part of the Tax Cuts and Jobs Act. Unlike previous proposals, which would tax carried interest income attributable to services as compensation income, Section 1061 simply reclassifies some carried interest income attributable to services as short-term capital gain. By choosing to treat carried interest income attributable to services as short-term capital gain instead of as compensation income, Section 1061 exempts such income from self-employment tax and allows taxpayers to offset such income with an unlimited amount of short-term capital losses. This paper reviews the requirements under Section 1061 and explains several ambiguities created by the new law. In addition, this paper examines whether Section 1061 follows sound tax policy. The authors find that Section 1061 does not follow the tax policy concepts of equity and fairness, economic efficiency, neutrality, simplicity, or certainty. In addition, the authors find that Section 1061 will have minimal impact, as most carried interest is held longer than the required period to qualify as long-term capital gain

Dis-Incorporation of the American Business Model

ABSTRACT The U.S. federal government raises most of its revenue from three sources: individual income tax, payroll tax, and corporate income tax. The corporate tax share of total federal revenue has declined dramatically over the last three decades, while tax from individual income has been consistent during the same period. There may be a number of reasons for the decrease in the contribution corporate income taxes make to federal revenues. One of those reasons may be that there has been a dramatic change in how businesses are being organized and operated in the United States. For many years, business entities could choose to operate as either a corporation or a partnership. However, currently, businesses can choose from a variety of entities in which to operate. This article will examine the changes in capital business formations and their impact on the federal revenue collected. In addition, the article will explore the tax policy implications of these new strategies.</jats:p

Financial Statement Aggressiveness Related to Tax Accounts and Tax-Related Accounting Misstatements

ABSTRACT In this study, we examine two questions: (1) whether financial statement aggressiveness related to tax accounts is associated with the likelihood of having tax-related misstatements in the financial statements, and (2) whether the disclosure of the need to restate prior years' financial statements for a tax-related reason influences tax-related financial statement aggressiveness related to tax accounts in the fiscal year of announcement. Recent evidence of an increase in the rate of tax-related accounting restatements motivates these questions. In this study, we find empirical evidence suggesting that tax-related financial statement aggressiveness is positively associated with the likelihood of having tax-related misstatements in the financial statements. We also find that in the year in which the need to restate prior years' financial statements is announced, companies with tax-related misstatements in their financial statements appear to be less tax-related financial statement aggressive compared to the control group.</jats:p

The aggressiveness of tax professional reporting: Examining the influence of moral reasoning

This chapter investigates the effect of moral reasoning of tax professionals on the aggressiveness of their reporting recommendations. The findings of the study indicate moral reasoning influences the aggressiveness of tax reporting decisions separate from the influence of client pressure. As the level of moral reasoning increases, the aggressiveness of the reporting position is found to0 decrease. Contrary to prior research, client pressure is not related to tax reporting aggressiveness. Failure to observe this relationship may signal a shift in behavior resulting from the intense public and regulatory scrutiny at the time of data collection which was in the immediate aftermath of the Enron scandal. Copyright © 2013 by Emerald Group Publishing Limited