What Private Equity Is Listening for in the State of the Union

In his State of the Union speech on Tuesday night, President Obama is expected to highlight a willingness to bypass Congress to get things done. That new stance could make private equity bosses nervous.

The Obama administration has an opportunity, stemming from a recent court decision, to try to change the tax treatment of private equity earnings, a tax expert has said. In theory, the Treasury Department and the Internal Revenue Service could act without Congress’ involvement to change how the existing tax law applies to this form of income, which is known as carried interest.

Ken Spain, a spokesman for the Private Equity Growth Capital Council, a lobbying group, said in an email on Tuesday that he did not expect Mr. Obama to mention carried interest or private equity in the speech directly.

“However, I think there might be some broader thematic elements that the issue of carry could fall under,” Mr. Spain said.

Carried interest â€" the profit that a private equity manager gets from running investment funds â€" is currently treated for tax purposes as capital gains, taxed at a 20 percent rate. Yet, a number of academics and lawmakers have argued that it should be treated as ordinary income because it is earned through active management rather than passive investment.

A court decision last year involving the private equity firm Sun Capital and a company it bought, Scott Brass, introduces a wildcard.

The decision held that a fund operated by Sun Capital â€" as distinguished from the firm itself â€" was engaged in a “trade or business” in its ownership of Scott Brass. The decision may have tax implications, because the premise of private equity taxation is that the funds are passive investors rather than active owners, Victor Fleischer wrote in his column in DealBook last summer.

Efforts to raises taxes on carried interest have not gotten far in Congress. But this case could provide an opening for the Obama administration, Steven M. Davidoff wrote in his DealBook column in October.

Mr. Davidoff wrote: “It may now be that this battle to tax carried interest is not won or lost in the halls of Congress over high-minded concepts of fairness or equity, but rather in the halls of the I.R.S. by applying common sense presumptions that existed all along.”

A spokesman for the I.R.S. declined to comment on Tuesday.

Defenders of the private equity industry scoff at the notion that this decision could change how carried interest is taxed.

“It is pure speculation to assume this will have any bearing on established tax law that has been in place for a century,” Steve Judge, the president and chief executive of the Private Equity Growth Capital Council, wrote in DealBook in November.

Private equity firms themselves, though, are aware of the possibility that their tax treatment could change.

“There remains some uncertainty regarding Blackstone’s future taxation levels,” the Blackstone Group said in a quarterly filing with regulators in November, noting legislative efforts to raise taxes on carried interest.

“If we were taxed as a corporation or were forced to hold interests in entities earning income from carried interest through taxable subsidiary corporations, our effective tax rate could increase significantly,” the filing said.