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Congress’ Carried Interest Proposals Will Affect Family Partnerships

Published: July 7th, 2010

By: Charles H. Egerton

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You may have read or seen news reports about a proposal advanced by Congressman Sander Levin, the current chair of the House Ways & Means Committee to tax income derived from a “carried interest” at maximum ordinary income tax rates. The proposal, which is endorsed by the Obama Administration, is ostensibly aimed at hedge fund and private equity fund managers who receive a share of partnership profits in exchange for managing fund assets. Under rules which have been a part of the partnership tax law for over 60 years and which are designed to facilitate the pooling of capital, assets and sweat equity to create a profitable venture, a party who contributes his expertise and/or management skills in exchange for an interest in partnership profits is entitled to be taxed on his proportionate share of partnership income in the same manner as any other partner. Thus, if the partnership generates taxable income consisting of both ordinary income and long-term capital gains, the service partner (who, more often than not, also has invested capital in the partnership) will be taxed on his proportionate share of each type of income.

Congressman Levin argues that this is just another example of the favoritism extended by the tax laws to Wall Street titans. He points out that the average Joe who renders services in exchange for compensation must pay taxes on this compensation at ordinary income tax rates and is also subjected to employment taxes in the form of FICA, FUTA and Medicare taxes. Why should hedge fund managers who receive a share of profits consisting of long-term capital gain derived from sales of stock and securities managed by the fund be treated any differently? Despite the fact that Mr. Levin glosses over a number of factors when he states the case for his proposal, few of us in Central Florida are terribly concerned about the plight of hedge fund and private equity fund managers whose annual income may run in the seven figures. What should concern us, however, is the fact that most of the additional tax revenues projected to be derived from this proposal will come not from Wall Street, but from small businesses organized as partnerships, limited partnerships and LLCs, many of which are family partnerships.

If you want to understand the breadth and likely consequences of the Administration’s proposed carried interest legislation that may become law in the near future, read the editorial entitled, “The Family Business Revenue Act”, in the June 24, 2010 edition of The Wall Street Journal.

The article cuts through the political hyperbole and correctly identifies family partnerships, particularly those holding real estate and securities, as the source of the greatest portion of the revenue that will be raised by this legislation.

If you are concerned about the possible enactment of the carried interest legislation, we encourage you to contact your U.S. Senators and/or Congressional Representatives. Click on these links to locate contact information for your U.S. Senators and Congressional Representatives: http://www.senate.gov/general/contact_information/senators_cfm.cfm?State=FL

http://www.house.gov/representatives/#state_fl

For more information on this proposed legislation, contact one of the tax attorneys at Dean Mead.

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We assist our business clients in selecting and establishing the best legal entity to conduct a business, including partnerships, LLCs, S corporations, and C corporations. Our Tax Team also assists our clients in all aspects of tax planning related to the operation of their businesses (whether a partnership, LLC, S corporation, or C corporation).

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A large part of our tax practice involves providing tax advice to our clients in connection with the sale and purchase of businesses, including mergers and other tax-free reorganizations, stock sales, purchases and redemptions, and asset sales and purchases.

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