Carried Interest Strategic Option (May 12)

Mike & Co. —
Returning to taxes before we re-return to tax returns and the eternal audit, we look at a bill gathering support in the Senate — a Democratic priority for close to a decade that everyone from Pres. Obama, Sen. Sanders, Jeb Bush and even Donald Trump has endorsed. 
No one thinks it can clear the Senate this year.  But can Obama circumvent the Senate and close the carried interest loophole by executive order?  Should he?
Best,
Dana
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Carried Interest:  a Strategic Decision
President Obama campaigned in 2008 on the promise of closing the carried interest loophole and it has been included in every one of the President’s budgets in office.  Its life on the list of Democratic priorities  raises the question:  can and, if so, should  the President used executive action to close the loophole?
The President has already used his executive powers to undertake sweeping reforms to immigration, education, and environmental policy — why not handle this the same way?
Executive Action — Parameters
Executive actions are a broad and sweeping power available to the President to direct the executive branch to undertake certain actions.  But the President cannot write his own laws.  While the President cannot use executive action to draft legislation from whole cloth, he can use it to interpret existing laws for the purpose of enforcing them.
So what does this mean for carried interest?  Assuming an executive order follows existing laws, then it’s a viable option for closing the loophole.
Executive orders have been challenged in courts frequently, leaving a rich history of decisions but little in the way of a predictable precedent.  A number of issues do come up repeatedly in these cases: does the order violate constitutional rights? Is the order authorized under existing law? Has the order been applied properly?
In domestic matters, the federal government has a roughly 85 percent win rate, according to a study which included 78 such cases brought before the Supreme Court and the Court of Appeals for the D.C. Circuit.
Executive Action — Options
Tax experts have laid out several avenues for the administration to pursue in an executive action.  The Treasury Department has an array of provisions which could enable it to move on carried interest, that much is clear, but the extent to which one provision is more appropriate than the others is still murky.
For example: Treasury, through the IRS, could pass a rule that changes the way carried interest is taxed by changing the timing of carried interest.  After all it was a 1993 IRS decision regarding gains realized from real estate sales that has been applied to carried interest until now.  Presumably all it would take is for the IRS to issue a new rule that deals with hedge funds specifically to close this loophole. Another option lies in section 707(a)(2)(A) of the tax code, which empowers the Treasury to write regulations addressing how partnerships like private equity firms issue compensation.
Treasury has the legal authority but it would mainly be IRS lawyers actually doing the drafting.  Section 707(a)(2)(A) of the Code, added in 1984, directs the Department of the Treasury to write regulations which address compensatory regulations between a partner and partnership. Treasury understands that it is a regulatory process subject to notice-and-comment under the Administrative Procedure Act, and not just an enforcement decision on the ground.
Both of these avenues would follow from the interpretation of existing statutes.  These cases have historically gone well for the federal government, with a win rate of roughly 90 percent.
Current Legislation
Sen. Baldwin’s Carried Interest Fairness Act, S. 1686, is just the most recent example of a bill aimed at carried interest, but both it and its sister bill (introduced by Sander Levin) are unlikely to pass — not a single GOP member supports them.
The major benefit for waiting on legislation is its permanence relative to an executive order.  If the President steps in to solve the carried interest problem then his successor could reverse his actions just as easily.  It’s much more difficult to repeal an existing law than it is to reverse an executive order.   It may also have value as a legacy issue for the President closing carried interest, but this could cut both ways.  Finally, this is not an either/or — both avenues can be pursued without prejudice.
Suggested Response
 
Q.   Should the carried interest loophole be closed and if so, how?
 
“I have long supported closing the carried interest tax loophole.  It unfairly supplements the salaries of fund managers, many of whom have astronomical salaries to begin with, on the backs of the middle class.
“What do Donald Trump, Bernie Sanders, Jeb Bush and Barack Obama, and Warren Buffett —  who says this loophole is reason he pays a lower tax rate than his cleaning lady — all have in common?  They all favor ending this tax break. It is subsidized by middle-class taxpayers to the tune of over $20 billion over ten years and adds as much to the deficit.
“Now I can do this by proposing it to Congress or by executive action.  I think we need to make it law, to make it stick beyond just my presidency, so I need a Congress that agrees….”

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