Baucus Extenders Legislation Would Reform Hedge Fund Managers Carried Interest

Senator Max Baucus (D-Montana), Chair of the Senate Finance Committee, has introduced a new iteration of the tax extenders legislation that, like previous iterations, reforms carried interest taxation of hedge fund managers and other asset fund managers. The legislation would prevent hedge fund and investment fund managers from paying taxes entirely at capital gains rates on investment management service income received as carried interest in an investment fund. To the extent that carried interest reflects a return on invested capital, the Baucus legislation would continue to tax carried interest at capital gains rates,

However, to the extent that carried interest does not reflect a return on invested capital, the legislation would require fund managers to treat 75 percent of the remaining carried interest as ordinary income starting Jan 1, 2011. The amount treated as ordinary income is reduced 50 percent for carried interest that does not reflect return on investment capital but which is attributable to a sale of assets held for 5 or more years. The lower recharacterization percentage also applies to a gain or loss to the underlying assets held for 5 years or more when a partnership interest is sold as well as to gain attributable to IRC Sec. 197 intangibles of an entity providing specific investment management services when the partnership interest has been held for 5 or more years.