WASHINGTON, DC – In an effort to restore an important measure of fairness to the tax code, U.S. Senator Jack Reed is seeking to close the “carried interest” loophole, which lets Wall Street managers at investment partnerships treat most of the money they make as capital gains rather than as ordinary income.

Reed has teamed up with U.S. Senator Tammy Baldwin (D-WI) to introduce the Carried Interest Fairness Act of 2015.  The legislation would ensure that income earned by investment managers of private equity, venture capital, and hedge funds is taxed at the same rate paid by the vast majority of Americans.

Under the current system, fund managers often get paid two percent of assets as a regular fee, plus twenty percent of the fund’s profits.  The managers pay regular income tax on the two percent, but when it comes to their share of the profits, which is called “carried interest,” they usually pay only long-term capital gains.  In a sense, they are converting income from labor into capital gains.  So even though the investors are putting up the fund’s capital and taking the bulk of the risk, the fund managers are able to treat their part of the fund’s earnings as a capital gain, subject only to a top taxable rate of 15 percent. 

The New York Times Economix blog notes: “Thus, on $1 billion of assets the managers would automatically get $20 million that would be taxed as ordinary income.  If the assets increased 10 percent to $1.1 billion, they would get another $20 million. For tax purposes, this additional $20 million would be treated as a capital gain and taxed at 15 percent.”

Meanwhile, other working Americans pay the ordinary income tax rates of up to 39.6-percent.

The Carried Interest Fairness Act would clarify that this income be subject to ordinary income tax rates, rather than the much lower capital gains rate.

“This commonsense legislation is about fairness.  The tax code should treat everyone equally, but under the current system, Wall Street fund managers get preferential treatment and are able to convert income from labor into capital gains.  Everyone has a right to earn their pay, but there shouldn’t be a special set of tax breaks just for the wealthy and well-connected.  Congress needs to close this loophole, simplify the tax code, and enact other sensible reforms that will strengthen our economy,” said Senator Reed, a senior member of the Senate Banking Committee. 

“Instead of simply rewarding the wealthy with tax preferences, Washington needs to do more to respect hard work, invest in economic growth, and give the middle class a fair shot at getting ahead,” said Senator Baldwin.  “At a time when too many Wall Street millionaires pay a lower effective tax rate than some truck drivers, teachers, and nurses, we need to eliminate this loophole and make sure those at the top are paying their fair share.”

According to President Obama's 2016 budget proposal, closing the “carried interest” loophole would reduce the federal deficit by $17.7 billion over the next ten years.

House Ways and Means Committee Ranking Member Sander Levin (D-MI), a long-time champion of closing the carried interest loophole, has reintroduced his version of the bill in the House.

In addition to Baldwin and Reed, the Carried Interest Fairness Act of 2015 is cosponsored by U.S. Senators Al Franken (D-MN), Sheldon Whitehouse (D-RI), Richard Blumenthal (D-CT), Mazie Hirono (D-HI), Joe Manchin (D-WV), Bernie Sanders (I-VT), and Elizabeth Warren (D-MA).