Steve Judge is president and chief executive of the Private Equity Growth Capital Council.
In a recent Deal Professor column, Steven M. Davidoff writes that a recent pension case decision involving Sun Capital Partners “upends the current tax treatment of carried interest.†The notion that a case involving the Employee Retirement Income Security Act, or Erisas, could be interpreted as a tax case to change settled carried-interest tax law requires the reader to take many leaps of faith (and logic) that run counter to several important facts.
The first is that the United States Court of Appeals for the First Circuit expressly admits that the case is not a tax law case and that its decision applies strictly to potential withdrawal liability in the Erisa multi-employer pension plan context.
The second is that both the Treasury Department and the Internal Revenue Service lack the authority to change the tax treatment of carried interest absent an explicit act by Congress. As former Treasury Secretary Timothy F. Geithner stated in a March 2010 letter exchange with Senator Sheldon Whitehouse, Democrat of Rhode Island: “These changes to current tax law require statutory changes, and unfortunately cannot be done by changes to administrative guidance.â€
It is true that the ruling could potentially have important implications for the private equity and growth capital industry within the Erisa context, even though it applies only in the First Circuit. But it is pure speculation to assume this will have any bearing on established tax law that has been in place for a century.
Carried interest represents a profits interest in a business, and the profits earned by private equity firms and their partners when they sell a business are appropriately taxed as capital gains. When a private equity firm sells a business - a capital asset - the tax treatment of the gain flows through to the partners. As the income tax code has appropriately recognized since its inception, the sale of a capital asset creates capital gain or loss, and that treatment flows through to the partners in the firm.
Taxing carried interest as anything other than a capital gain would deny private equity, venture capital and real estate partnerships the same long-term capital gains treatment available to other kinds of businesses that sell a long-term capital asset for a profit.
Private equity partnerships invested more than $347 billion of long-term capital into the United States economy last year, and increasing taxes on carried interest would hurt partnerships that strengthen thousands of companies across the country. Even critics of carried interest say there are no shortcuts for changing this longstanding tax law outside the legislative process.
