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Romney’s earnings prompt renewed attention to carried interest taxation

January 19, 2012

Romney-2012-official-campaign-site2Mitt Romney's "around 15 percent" tax rate has emboldened not only his rivals for the Republican presidential nomination, but also the top Democrat on the tax-writing House Ways and Means Committee.

It's a pretty safe assumption that much of Romney's estimated $250 million net worth is via investment earnings that receive favorable capital gains tax treatment.

But thanks to a tax code loophole, that 15 percent rate probably also applied to some of Romney's compensation from the private equity group Bain Capital.

When private equity executives and hedge fund managers are paid by taking a share of their firm's profits instead of a regular salary, those execs are allowed to classify their income as a capital gain rather than a wage.

That compensation recharacterization, known as carried interest, means that instead of potentially paying a top 35 percent tax rate on their salaries, they pay just 15 percent tax on the money.

Not a new issue: This arrangement has long been a target of tax reformers.

Carried interest got wider popular attention in 2008 when tax law professor Victor Fleischer wrote about "this quirk in the tax law [that] allows some of the richest workers in the country to pay tax on their labor income at a low rate."

Fleischer argued in his academic paper that the "two and twenty" (a two percent management fee and 20 percent profits interest) payment structure is "an untenable position as a matter of tax policy. Among the various alternatives, perhaps the best starting point is a baseline rule that would treat carried interest distributions as ordinary income."

That tax law change was tried most recently in May 2010, when some members of Congress wanted to tweak the carried interest rules as part of the tax extenders package.

At that time, it was proposed to that carried interest income be treated as 50 percent ordinary income and 50 percent capital gains through 2012. In 2013, the proposal would tax carried interest as 75 percent ordinary income and 25 percent capital gains.

Didn't happen.

Try, try again: But Ways and Means Committee Ranking Member Sander Levin is ready to try again.

The Michigan Democrat has twice before authored legislation to tax carried interest compensation at ordinary income tax rates. Levin announced this week that he will reintroduce the carried interest bill again this year.

The previous versions of Levin's carried interest tax change bills passed the House four times as part of broader legislative measures. The proposal, however, has run into trouble in the Senate.

2012, however, could be the year.

The combination of Occupy Wall Street protests, talk of 1 percenters and the presidential campaign focus on Romney's compensation and tax rate history might just provide the momentum necessary to change the way carried interest is taxed.

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TO WRAP UP 2026

It’s over! With October’s extended filing deadline behind us, it is now time to focus on year-end moves to reduce your 2026 tax bill. 

You’ll find ways to do just that on the Tax Tips page (see the More Tax Posts drop-down menu at the top of the blog), as well as the separate tax tip pages for each month, notably October through December. If you’re on the Tax Tips page, you’ll find a monthly list at the end of this column. If you’re on another blog page, you can head straight to the October tips; at the bottom of that tips page you’ll find links to all the other 11 months’ collections of tax advice.

Not to spoil what you’ll find in that tax advice, but it does cover such things as tax deductions for charitable donations, investment moves that could reduce tax due, and ways to max out your tax-favored retirement savings. 

Finally, as the year winds down, things get hectic. There are lots of other things to occupy our time, like the much more fun upcoming holidays. But don’t lose sight of taxes, since timing is key. To be of use, most tax moves must be made by the end of the tax year. That’s Thursday, Dec. 31, which also is the last business day of the year. 

So that you don’t miss that final tax year deadline, also keep an eye on the countdown clock below. It will keep you on top of just how much time is left to make important, tax-saving moves. (Note: I’m in the Central Time Zone, so adjust accordingly for where you live.)

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