Bills Introduced to Change the Taxation of Investment Funds

As discussed in the Perkins Coie update "Senate Finance Committee Reviewing Taxation of Investment Funds," Congress has begun a wide-ranging review of the taxation of investment funds. This review first led to the introduction of bills in the Senate and the House that would subject a small number of publicly traded investment funds to corporate tax.

Last Friday, however, 13 House Democrats, including Ways and Means Committee Chairman Charles Rangel and House Financial Services Committee Chairman Barney Frank, introduced a bill (H.R. 2834) with broader applications. Under this bill, income from certain carried interests in investment funds (whether or not interests in the fund are publicly traded) would be subject to tax at ordinary income tax rates, even if that income represents a share of the fund's long-term capital gains. In addition, gain from the disposition of these interests would constitute ordinary income. Under current law, ordinary income of individuals is subject to a maximum federal rate of 35%, while long-term capital gains of individuals are subject to a 15% maximum rate.

Partnership interests that potentially would be subject to this ordinary income treatment include interests held by a partner that provides advisory, managerial or similar services to a partnership with respect to securities, real estate or commodities, or options or other derivatives relating to any of these assets. Accordingly, the bill's ordinary income rule would generally apply to the carried interest in private equity and venture capital funds, as well as the carried interest in investment funds holding real estate and commodities.

H.R. 2834 does not contain an effective date provision. A Ways and Means Committee fact sheet states that decisions on the effective date "will be made as part of the legislative process."