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Thursday, March 17, 2011

Taxation of Hedge Fund and Private Equity Managers

Mark Jickling
Specialist in Financial Economics

Donald J. Marples
Section Research Manager

Hedge funds and private equity funds are investment pools generally available only to institutions and wealthy individuals. Private equity funds acquire ownership stakes in other companies and seek to profit by improving operating results or through financial restructuring. Hedge funds follow many strategies, investing in any market where managers see profit opportunities. The two kinds of funds are generally structured as partnerships: the fund managers act as general partners, while the outside investors are limited partners. General partners are compensated in two ways. First, to the extent that they invest their own capital in the funds, they share in the appreciation of fund assets. Second, they charge the limited partners two kinds of annual fees: a percentage of total fund assets, and a percentage of the fund’s earnings. The latter performance fee is called “carried interest” and is treated as capital gains under current tax rules.

In the 112
th Congress, the President’s Budget Proposal calls for taxation of carried interest as ordinary income. In the 111th Congress, the House-passed American Jobs and Closing Tax Loopholes Act (H.R. 4213) would have treated a portion of carried interest as ordinary income. Additionally, the Tax Extenders Act of 2009 (H.R. 4213), H.R. 1935, and the President’s 2010 and 2011 Budget Proposals would have made carried interest entirely taxable as ordinary income. Further, other bills introduced in the 110th Congress would also have redefined the tax treatment of carried interest. S. 1624 would have required private equity firms organized as publicly traded partnerships to pay corporate income tax, while H.R. 4351 and H.R. 6049 would have included in gross income the portion of carried interest currently deferred offshore in foreign-chartered funds. In addition to summarizing the legislation, this report provides background on hedge funds and private equity and summarizes the tax issues.

Date of Report: March 10, 2011
Number of Pages: 9
Order Number: RS22689
Price: $19.95

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