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Those taxes are not avoided - it's just the current tax law. Money put at risk is taxed as capital gains. You don't automatically get carried interest - if you

Those taxes are not avoided - it's just the current tax law. Money put at risk is taxed as capital gains. You don't automatically get carried interest - if you don't perform, it's zero. Think of it as a portion of their salary that they are contractually bound to invest in the fund, with deference to the limited partners. Do we really want to have fund managers without skin in their own funds? Carried interest is the only way to do that that does not favor the fantastically rich - who have enough advantages already. Ask yourself what might happen to the private fund industry (VC, PE, hedge funds, real estate, etc) if managers were not able to get carry. How would their compensation change? Which funds would benefit? Do we really want that?

inthewoods 12y ago
It's not an issue of whether someone should get carried interest - it's an issue of the rate at which that carried interest is taxed. Funds are essentially providing a service for a given investor but getting taxed as though it was all their own money in the fund - which is not the case in most funds. Instead, what the funds are doing is essentially providing investment advice - for which the fees should be taxed at normal rates rather than at the carried rate as though it is all their own money. So I have no issue with the manager getting carried interest or being taxed at lower rates on their own money - but when they take money from outside investors, they should be taxed at normal rates.
- damoncali 12y ago
  I won't argue that our tax code is anything but ridiculous. But treating carried interest and capital gains the same way makes sense - it's money put at risk as an investment. I don't think it's relevant that in one case cash is risked and in another case it's compensation at risk. Nobody is goign to argue that the management fee is capital gains because it isn't - it's guaranteed cash. It's different. I think you can argue that capital gains shouldn't be taxed differently than income at all (not sure what I think of that, honestly), but if carried interest has to be in either the "income" bucket or the "gains" bucket, it looks more like gains to me.
  - inthewoods 12y ago
    "I think you can argue that capital gains shouldn't be taxed differently than income at all (not sure what I think of that, honestly), but if carried interest has to be in either the "income" bucket or the "gains" bucket, it looks more like gains to me." Looks more like income to me - fees paid to people for managing money that they themselves have not put at risk.
    - damoncali 12y ago
      But they have put it at risk. You don't think they'd demand (and get) more salary if they didn't get carried interest?
      - inthewoods 12y ago
        Again, we're not talking about getting carried interest - we're talking about the taxes on that carried interest. They put the capital at risk, but this is no different than any fee-based service, thus it is income rather long term capital gains.
        damoncali 12y ago
        If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains. What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don't get a tax benefit if you lose that money in the CI case (which happens a lot), so it balances out at least to a degree.
        inthewoods 12y ago
        I'd have no issue with their own investments in the fund being taxed as long term capital provided they have held the investment for a year when the profit is taken. Here's a simple way to think about it - an ordinary RIA invests money on behalf of their clients. The fees they get for that service are taxed as ordinary income. Why should carried interest be any different when the money is coming from clients? And why should carried interest be taxed at a lower rate regardless of hold time? The simple answer is that these fees aren't any different - and therefore should be taxed at the same rate in my opinion.
hsitz 12y ago
"Money put at risk is taxed as capital gains." Huh? Money that hedge fund owners provide as fund capital is already theirs, they don't pay tax on it at all. Of course gains in value of their capital investment are taxed as capital gains. But the performance fees we're talking about are fees that accrue to hedge fund managers from managing _other people's money_, not the capital gains that manager's realize directly as the increase in value of their own investment. If hedge fund managers could not performance fees categorized as carried interest they'd pay regular income tax rates on them. Not sure how that changes their management of the funds. Presumably if they believe they're the best managers out there they'll want to have their own assets in their fund (and of course will pay only capital gains tax on increases in value of their assets). By the way, high percentage of hedge fund managers are already among the "fantastically rich". . . .

inthewoods 12y ago

It's not an issue of whether someone should get carried interest - it's an issue of the rate at which that carried interest is taxed. Funds are essentially providing a service for a given investor but getting taxed as though it was all their own money in the fund - which is not the case in most funds. Instead, what the funds are doing is essentially providing investment advice - for which the fees should be taxed at normal rates rather than at the carried rate as though it is all their own money. So I have no issue with the manager getting carried interest or being taxed at lower rates on their own money - but when they take money from outside investors, they should be taxed at normal rates.

damoncali 12y ago
I won't argue that our tax code is anything but ridiculous. But treating carried interest and capital gains the same way makes sense - it's money put at risk as an investment. I don't think it's relevant that in one case cash is risked and in another case it's compensation at risk. Nobody is goign to argue that the management fee is capital gains because it isn't - it's guaranteed cash. It's different. I think you can argue that capital gains shouldn't be taxed differently than income at all (not sure what I think of that, honestly), but if carried interest has to be in either the "income" bucket or the "gains" bucket, it looks more like gains to me.
- inthewoods 12y ago
  "I think you can argue that capital gains shouldn't be taxed differently than income at all (not sure what I think of that, honestly), but if carried interest has to be in either the "income" bucket or the "gains" bucket, it looks more like gains to me." Looks more like income to me - fees paid to people for managing money that they themselves have not put at risk.
  - damoncali 12y ago
    But they have put it at risk. You don't think they'd demand (and get) more salary if they didn't get carried interest?
    - inthewoods 12y ago
      Again, we're not talking about getting carried interest - we're talking about the taxes on that carried interest. They put the capital at risk, but this is no different than any fee-based service, thus it is income rather long term capital gains.
      - damoncali 12y ago
        If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains. What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don't get a tax benefit if you lose that money in the CI case (which happens a lot), so it balances out at least to a degree.
        inthewoods 12y ago
        I'd have no issue with their own investments in the fund being taxed as long term capital provided they have held the investment for a year when the profit is taken. Here's a simple way to think about it - an ordinary RIA invests money on behalf of their clients. The fees they get for that service are taxed as ordinary income. Why should carried interest be any different when the money is coming from clients? And why should carried interest be taxed at a lower rate regardless of hold time? The simple answer is that these fees aren't any different - and therefore should be taxed at the same rate in my opinion.

hsitz 12y ago

"Money put at risk is taxed as capital gains." Huh? Money that hedge fund owners provide as fund capital is already theirs, they don't pay tax on it at all. Of course gains in value of their capital investment are taxed as capital gains. But the performance fees we're talking about are fees that accrue to hedge fund managers from managing _other people's money_, not the capital gains that manager's realize directly as the increase in value of their own investment. If hedge fund managers could not performance fees categorized as carried interest they'd pay regular income tax rates on them. Not sure how that changes their management of the funds. Presumably if they believe they're the best managers out there they'll want to have their own assets in their fund (and of course will pay only capital gains tax on increases in value of their assets). By the way, high percentage of hedge fund managers are already among the "fantastically rich". . . .