Taxation & Private Equity Funds
Private equity funds, which are designed to buy and sell interests in privately held businesses, are organized as partnerships. As such, they don't pay income taxes. Income passes through partnerships to the investors. But the income of the managers of these funds is subject to taxation.
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Types of Income
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If you bought low and sold high, the difference is capital gain. An individual or entity subject to U.S. federal income tax pays that tax at graduated rates. The scales involved differ depending on whether the income is considered ordinary income or capital gain. For 2010, the highest rate of taxation for ordinary income is 35 percent. The highest rate for capital gain is 15 percent.
Significance
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The general partners who manage a private equity fund receive a share of its profits as part of their compensation. This share is known as the "carried interest," and it is traditionally taxed at the lower capital gains rate rather than as ordinary income.
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History
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In May 2010, reformers introduced into the House of Representatives a bill that would tax 75 percent of carried interest at the higher rate of ordinary income. The extra revenue raised would offset the costs of extending unemployment compensation benefits. However, by the time the benefits extension bill became law, in late July, it had been stripped of any reference to carried interest.
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References
- Photo Credit a pig on money i image by Mykola Velychko from Fotolia.com
