A GOP lawmaker says he’s sticking it to hedge funds with a new tax rule — he’s not

Chairman of the House Ways and Means Committee Kevin Brady (R-TX) holds a sample tax form as he unveils legislation to overhaul the tax code on Capitol Hill in Washington

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Chairman of the House Ways and Means Committee Kevin Brady (R-TX) holds a sample tax form as he unveils legislation to overhaul the tax code on Capitol Hill in Washington
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Thomson Reuters

    Republican lawmaker Kevin Brady introduced an amendment that would alter a long-standing tax provision called carried interest – and could raise taxes on Wall Street managers that keep holdings for less than three years. Brady said the change would prevent hedge-fund managers from taking advantage of the tax benefit, but they aren’t the Wall Streeters using it. Currently, carried interest allows investment managers to have capital gains taxed at a lower rate than normal income tax if they hold the holding for at least one year. It’s a big benefit for private-equity funds and other long-term investors. Very few hedge funds actually take advantage of it because they trade in and out of investments much more frequently. Other politicians have also confused the issue. Democratic Senator Tammy Baldwin called to end carried interest in regards to hedge-fund managers.

An amendment to the Republican tax bill touted as a blow to hedge-fund managers isn’t going to affect most of them.

Earlier this week, Republican Representative Kevin Brady, chairman of the House tax-writing panel, offered to make changes to the rules on carried interest, a tax provision that largely benefits private-equity funds and other investors that hold their investments for more than one year. President Trump and his then-competitor Hillary Clinton both called to ending carried interest during their campaigns.

Brady’s amendment raises the threshold on what can qualify as a long-term investment and be taxed at a lower rate. He wants investment managers to have to hold onto something for three years before the can get the benefit, up from one year now. The Ways and Means Committee, which he chairs, tacked on the amendment to the tax bill Monday.

In an interview with CNBC on Monday, Brady said increasing the holding limit “makes sure you don’t have the giant hedge funds sort of spinning in and out of that…It puts [carried interest] back to its original intent, which is to reward over long term holdings, those who put skin in the game and work to make the skin in the game better.”

But carried interest actually doesn’t apply to most hedge funds. In a statement from the Ways and Means committee, which Brady chairs, a spokesperson said: “The Tax Cuts and Jobs Act will encourage and reward long-term investment while also applying equally to all sources of growth capital – no matter if that investment is provided by hedge funds, private equity, venture capital, or otherwise.”

Currently, hedge-fund, private-equity, real estate managers and other investors like venture capitalists qualify for the lower capital gains rate if they hold an investment for one year. Those capital gains are then taxed at a maximum 23.8%, compared to a top rate of 43.4%. This is a huge tax break for the Wall Streeters who qualify.

What the data says

Already, few hedge funds benefit from the current carried interest rules. The majority – 62% – hold their investments for less than one year, according to data from eVestment. And only a relatively small number of hedge funds would be caught up in Brady’s amendment if passed. Only 15% report holdings for more than two years, according to eVestment.

Brady’s rule also would not affect the vast majority of private equity managers. The average holding period for private equity funds this year is 5.3 years – more than two years above Brady’s limit, Preqin data shows. Seventy-seven percent of private equity deals are held for more than three years, meanwhile, according to Preqin.

The vast majority of private equity deals would not be affected by the Brady amendment.

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The vast majority of private equity deals would not be affected by the Brady amendment.
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Preqin.

If anything, the current carried interest rules are most likely to help private equity funds – not hedge funds – since only 3% hold their positions for less than a year, according to Preqin.

“Three years is likely to be ineffective,” said Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center.

As for venture capital, since 2000, 52% of venture-capital positions have been held for more than three years, according to data from PitchBook.

Talk about carried interest in regards to Wall Streeters is irrelevant given there’s another provision in the proposed GOP tax bill, on pass-throughs, which could cut fund managers’ taxes by huge amounts, according to Josh Bivens, research director at the Economic Policy Institute. The proposed rule would allow businesses to cut their top tax rates from 39% to about 25% by reorganizing how they’re structured, Bivens said.

To be sure, Brady isn’t the only politician to confuse who is affected by carried interest. In a letter Wednesday to the Senate Committee on Finance, Democratic Sen. Tammy Baldwin wrote: “This change will not affect the majority of partnership investments, which are longer than three years.”

But, she pointed to “wealthy and powerful hedge fund managers” in calling to end carried interest.

With assistance from Bob Bryan