529 Accounts and Tax Fairness

Tax changesPresident Obama recently announced a series of tax changes he will propose or at least politically push for in the coming year.

Since the US Congress constitutionally controls the power of taxation, and Congress likes Obama as much as I like Pete Carroll’s Seahawks, I understand that Obama’s priorities may not come to pass any time soon.

Still, I got mad when I read this week that Obama proposes ending the tax advantages of 529 education savings accounts.[1]

seattle_seahawks_suck
I like Seattle like Congress likes Obama

My first thought: “That’s not fair!”

My second thought (and one of my favorite family mottos): “’Fair’ is for kids.”[2]

My third, kind of extended, thought: While nobody actually enjoys paying taxes, a key test of the acceptability of a tax is whether it seems ‘fair.’ And tax breaks, just like taxes themselves, also have to seem, and be, basically ‘fair.’

How do we know if something is fair? It depends a tremendous amount on which taxes one pays and which tax breaks one takes advantage of.

In the case of 529 education accounts, I had always considered them an extremely fair tax break, combining one virtue (long-range savings) with another virtue (higher education) with compound interest (the greatest of all possible things in the known universe).

529 accounts

But of course, 529 accounts are fair, to me, because I’ve started them for my young girls. I appreciate and value the tax break on future capital gains because I have a chance to benefit from them when my girls go to college.[3]

For people who haven’t started 529 accounts, or have no chance of investing for their kids this way, the tax breaks may appear targeted at some unattainable upper-middle class, college-bound elite, and therefore the tax break is inherently unfair.

I was interested to read yesterday in the Wall Street Journal the White House’s argument that 70% of benefits of 529 accounts go to households with incomes over $200,000, or the top 4% of tax returns. I hadn’t known that, nor had I imagined the benefits of 529 accounts were enjoyed by so few.

In the light of that data, my fair tax break seems a little less fair. Or at least, it seems like something that could be eliminated and replaced with something that would have a broader benefit.

Not that it’s going to happen anyway, because Obama doesn’t make tax policy, Congress does.

 

PS – 4 days after I posted this, Obama backtracked and said he won’t push for a change in 529 Accounts, after taking flak from both Dems and Repubs.

 

Please see previous posts on 529 Savings such as:

Compound Interest and College Savings

The insanely rising cost of college – Interview with a College Advisor

Is the financial model for college broken – Part 2 of Interview with College Advisor

College Savings vs. Retirement Savings

 

And previous posts on taxation such as:

Shhh…Please don’t talk about my tax loophole

Adult conversation about tax policy

 

[1] Importantly, on the issue of fairness, Obama proposed eliminating tax breaks for future investment growth obtained on contributions to a 529 account, not for investment growth on past or existing investments in 529 accounts. In other words, there’s a grandfather clause for existing 529 amounts, a common key ‘fairness’ element to taxation changes.

[2] My favorite kid and ‘fairness’ story in my family, which I’ve mentioned in another post: My then-4year-old niece told us all over dinner “It would be fair, to me, if you gave me a bubble bath after dinner.” She knew fairness mattered to adults, and tried to shoehorn her interest in bubble baths into an adult framework. She’s seventeen now and soon off to college. Cool kid. Ever after, I try to use the “It would be fair, to me…” argument with my family as much as possible.

[3] Here my wife and I always add “should they choose that path.” Because they may decide instead to run away with the circus. My older one is pretty good on the rings at the gym.

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The Good Old Days of Filing Income Taxes – 1948 Edition

taxes_dueFor Throwback Thursday, the first day of Spring, and just three weeks until income tax returns are due, I offer up this vintage 1948 Federal income tax for 1040.

My friend – whose grandfather worked in the steel industry in Youngstown, OH – found his old tax return and thought Bankers Anonymous readers would get a kick out of it.

I don’t know why I get a kick out of it, but I do.

Some things remain the same from those times until now, including incurring a ‘loss’ on rental property.  That trick never goes out of style.  Rents, however, have gone up considerably since the $210/year for a duplex rate in 1948.  I can see on the form that he bought the duplex for $11,000 in 1948, so I guess he didn’t need to make that much in rent.

His income as a machinist for the Truscan Steel Company totaled $4,285, and since he’d already had $281.90 withheld, he qualified for a refund of $57.46, according to this return. Hopefully he stayed far away from the 1948 equivalent of an H&R Block refund anticipation loan.

The biggest change from then until now – besides the nominal level of prices – is the relative simplicity of the tax form. It looks like he filled this out in about 10 minutes.

As I look forward (with dread) to spending hours gathering tax information this coming week, only to pay thousands to my accountants, I wish doing ones taxes was not so complicated. The complication itself leads to sub-optimal outcomes.

1948_tax_return
Youngstown OH steel worker, tax return 1948

Please see related posts:

The problem of tax code complexity

Don’t prepare your own taxes

The ridiculously complicated Traditional IRA Algorithm Infographic for 2012

Adult conversation about income tax policy

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The Problem of Tax Code Complexity

The Taxes is Too Damn Complicated!
The Taxes is Too Damn Complicated!

With the nightmare US debt default temporarily avoided, let’s review some basics.

The budgetary responsibility of the US Congress has two parts:

1. Set spending levels (money outflow) and

2. Set taxation levels (money inflow)

Congressional rhetoric in the recent nonsense weeks mostly focused on spending (money outflow), whereas the harder but more meaningful discussion should be about taxation (money inflow).

We know this happens because neither we the public – nor our Congressional leaders – have the capacity to take on the complexity of taxes.

I mean ‘capacity’ in a couple of senses.

The first most relevant sense of capacity is: cojones.  It takes political courage to engage in a conversation about taxes.  It takes leadership to engage in a conversation about taxes.  It’s risky to engage in a conversation about taxes.  Hence: No capacity to talk about taxes.

I also mean capacity in the sense of intellectual firepower.

Federal taxes are so darned complicated at this point that we just don’t have the required gigabytes and RAM inside our skulls.  The human brain 1 cannot adequately capture all the parts of our tax policy.  The Federal tax code defies our understanding.

Imagine a world in which we needed to precisely legislate the movement of quarks and protons, with respect to the Higgs Field. 2

Imagine a policy discussion about this
Imagine a policy discussion about this

I’m picturing Harry Reid and John Boehner in a debate about the Higgs Field:

“DERR, THE AMERICAN PEOPLE DEMAND A PARTICLE ACCELERATOR WITH THE ENERGY OF 12 FLEX CAPACITORS.”

“GNNNGHHHH, MY CONGRESSIONAL OPPONENT IS BADLY MISGUIDED.  PATRIOTIC AMERICANS ALL SUPPORT A MORE RAPID ACCELERATION TO RELEASE ELECTRON MASS VIA THE BIFURCATED INVERTABRATOR.”

One point is, obviously, that I know nothing about the Higgs Field.3

The other, more serious, point is that our tax laws have gotten so complex that we can no longer expect Congressional leaders to understand anything but the most simplified ideological tripe 4; nor can we, citizens and voters, meaningfully engage in the topic either, for the same reason.

We’re structurally inhibited when it comes to budget policy and discussion by the existing complexity of taxes.

Tax Complexity Paper

All of this was on my mind this week when I read this paper about “Tax Complexity, History and Humor.”

Investment advisor David Hultstrom 5 recently linked to it in his newsletter, and despite its intimidating name, there’s quite a bit of both fun and information, worth your while.

A few highlights from the paper:

The loopholes, the humorous quotes, the expert disagreement

 

1. Inexplicable loopholes in the tax code:

 

  •        Whaling Charitable Deduction. Code §170(n) reads: ” In the case of an individual who is recognized by the Alaska Eskimo Whaling Commission as a whaling captain charged with the responsibility of maintaining and carrying out sanctioned whaling activities and who engages in such activities during the taxable year, the amount described in paragraph (2) (to the extent such amount does not exceed $10,000 for the taxable year) shall be treated for purposes of this section as a charitable contribution.”
  •           Parsonage Deduction. Code §107 provides: “In the case of a minister of the gospel, gross income does not include: (1) the rental value of a home furnished to him as part of his compensation; or (2) the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.” This income exclusion applies even if the minister receives the non-taxable parsonage allowance to cover real estate taxes and mortgage interest that the minister deducts on a personal income tax return.
  •         Parsonage Allowance after Retirement. Pursuant to Code §1402(a)(8) any parsonage allowance provided to a minister after retirement is not subject to self employment or social security taxes.
  •          Newsboys. Pursuant to Code §§3401(a)(10), 3121(b)(14) and 3306(c)(15), the earnings of certain people paid for newspaper delivery are not subject to FICA or FUTA taxes.

…you get the idea.

 

2.  Humorous Tax Quotes:

  •  “If Patrick Henry thought that taxation without representation was bad, he should see how bad it is with representation.” 

  • “A society which turns so many of its best and brightest into tax lawyers may be doing something wrong.”

  • “For every Tax Problem there is a Solution which is Straightforward, Uncomplicated and Wrong

  • Hiring a tax expert isn’t always a help. If you give the same problem to three tax experts, you are likely to get at least six different answers.”

  • A tax lawyer is a person who is good with numbers but does not have enough personality to be an accountant.” James D. Gordon, III

  • Definition of a Tax Attorney: Someone who solves a problem you didn’t know you had in a way you don’t understand. “

 

3.    And even the paid experts cannot agree:

 

  • In 2007 USA Today provided five tax preparers with a set of facts and asked each of them to prepare an income tax return. The five preparers produced five different tax results and could not agree among themselves on which result was correct.

  • From 1987 to 1998, Money magazine conducted an annual study in which it submitted facts to a group of tax return preparers. In Money’s 1998 report, forty-six tax return preparers had forty-six different tax results, with the tax liability ranging from $34,240 to $68,912. This was the 7th time that Money noted that none of the tax return preparers came to the same conclusion.

  • In an April 4, 2006 report, the Government Accountability Office noted that it submitted tax preparation information to nineteen commercial tax preparers around the US to determine how accurate their work was. Every one of the completed returns contained errors and some overlooked common deductions.

  • But it is not just the tax preparers who are confused. In 2002, the IRS reported that 28% of the answers given by its call centers were wrong, 12% were incomplete and 12% of the time taxpayers’ questions were not answered and taxpayers were told to do their own research.

  • If the tax professionals don’t know how to handle the complexity of our tax laws, what hope does the average taxpayer have?

My own attempt to illustrate tax complexity

As a thought experiment/illustration of the complexity of tax law, I created an infographic last Spring on just a tiny (but important!) portion of the tax code – the rules for making individual IRA contributions.  The visual joke of course is that this little thing is extraordinarily confusing, and we wonder why more people do not fund their individual IRAs.

At the very least, do not try to do your taxes on your own, as I wrote about on tax day this year.

No solutions at this point

I have no realistic solution to offer with respect to simplifying tax codes, except my belief that the complexity itself causes bad budgetary policy.   Including the kind of nonsense we all just endured from Congress.

As with investing, complexity is usually the enemy of the good.  If you can’t understand it, it’s more likely you’ll have suboptimal thoughts about it, and suboptimal decisions.

 

Please see related posts on taxes:

 

2012 IRA Contribution Infographic

Do NOT Do Your Own Taxes

A Tax Proposal Worth Considering

Shhh Please Don’t Talk About My Awesome Tax Loophole

Adult Conversation About Income Tax Policy

 

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  1.  Until a sufficient number of aliens complete a sufficient number of abductions leading to brain enhancement surgeries, obviously.  But I don’t expect this kind of work to be complete until the year 2035, and SOCIAL SECURITY WILL BE BANKRUPT BY 2032!  WE DONT HAVE ENOUGH TIME FOR ALIEN BRAIN-ENHANCEMENT SURGERIES!  GAH!
  2.  Warning:  I have no idea what I’m talking about here.  What follows is merely an analogy, and a dramatic re-enactment of a theoretical discussion between our Congressional leaders.  The actual Congressional debate  about Higgs Boson is likely to be even more inane.
  3.  Except this!  On the day Higgs won the Nobel a few weeks back, The New York Times linked to an awesome graphic illustration of the Higgs field.  Ok, I confess, the entire analogy was a set-up to show off this amazing graphical illustration.
  4.  Left unaddressed here is the fact that while we lack a capacity to understand the tax code as a whole, our business and Congressional leaders are very capable of creating narrow loopholes for their narrow benefit.  That’s relatively easy.  So that’s usually what we get.
  5.  I have no relationship with, or info about, David Hultstrom except that I’m on his free newsletter mailing list, and that his monthly and quarterly letters are totally awesome.

On Entrepreneurship, Part III – the air, the taxes, the retirement

tps report formThe air is just different owning business equity rather than earning a fixed income with a salary.  Can you smell it?

I left Goldman in 2004 and have been downwardly mobile, career-wise, ever since. 

I’ve also never been happier.

I’ve written before that one of the keys to feeling and being wealthy is do something that you love and that you would do regardless of the compensation. 

Now, I can’t prove the following statements, but I believe them to be true:

Working for yourself, in a business you founded, makes it much more likely that you’ll do something you love. 

Working for someone else, for a salary, makes it much more likely that you’ll be asked to come in on Saturdays to work on the TPS reports.   And, um, Yeeeeahhh, that’d be great.

TPS Reports thatd be great

It’s weird to say this, but it’s true:  Doing the TPS reports for your own business doesn’t feel that bad.  Even on Saturdays, it’s kinda fun.

Doing the TPS reports on a Saturday for someone else, however, encourages the kind of anomic existentialism that puts you in deep communion with the overwhelming sadness of the universe.

In life, there’s no getting away from the TPS reports on Saturdays, there’s only a choice about how it will feel.  One of my main arguments for starting your own business is that it feels different.

And now for some less important, but still relevant, arguments in favor of entrepreneurship.

Taxes

The tax code was written by and for business owners,[1] not by or for salaried employees.  So if you’re ever curious why taxes for salaried employees seem unfair, whereas businesses seem to pay less in taxes, that’s why.

Retirement

Did you know you can save about 3 times more per year in tax-advantaged retirement accounts if you’re a business owner than you can as a white-collar employee earning a salary, with a 401K plan?  It’s true.  But don’t just trust me, look it up on The Google.  The Google never lies.

More importantly, many successful business people want to control the timing and conditions of their own retirement, on their own terms. 

When you do someone else’s TPS reports, the company gets to ‘retire’ you when they choose.  When you do your own, you choose. 

Not everyone wants to work forever, but for those people who do, business ownership gives you the control and options.

 tps reports mug

Please see previous post on Entrepreneurship Part I – The difference between equity and fixed income

And Entrepreneurship Part II – Lessons from finance

 


[1] With help from Max Baucus’s former Senatorial staffers, of course.

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A Tax Proposal Worth Considering

The Center for American Progress (CAP) recently published a summary description of their proposals for addressing tax and spending policy, in the light of the ‘Fiscal Cliff,’ Simpson-Bowles, and the ongoing flustercluck of fiscal policy negotiations going on before January 1, 2013.

Their summary report is as good as anything I’ve seen yet in terms of both credibility and reasonableness for addressing tax policy and fiscal deficits.

Who is the Center for American Progress?  The CAP represents the Clinton Wing of fiscal policy, with such getting-the-band-back-together Clinton Administration veterans as Bob Rubin, Larry Summers, Roger Altman, William Daley, John Podesta, and Leslie Samuels.  Before you roll your eyes at those same-old left-of-center Democrats, consider the facts:

  1. This team produced fiscal surpluses at the end of the Clinton Administration[1]
  2. This team cut Welfare
  3. This team is EXTREMELY Wall Street friendly

And, so, now that I’ve established why both the Left and the Right will hate whatever these guys propose, my reply to the haters is that they have fiscal and financial credibility in a way nobody from the Bush era can claim, and they are far from being European Socialists when it comes to policy.

Some specific things I like about the CAP proposals:

  1. They eliminate the ‘Carried Interest’ loophole, which I wrote about here.
  2. They tax dividends like ordinary income – as they were taxed for 90 years before 1993[2]
  3. They raise long-term capital gains taxes from 15% to 28% – as they were taxed after the Reagan tax reform of 1986[3]
  4. They limit the kind of tax breaks which disproportionately favor high earners, such as mortgage interest tax deductions[4]
  5. They simplify and reduce the need for itemization of one’s personal tax returns
  6. They eliminate the Alternative Minimum Tax, aka the Tax Accountants and Preparers Full Employment Act[5]

Here’s the most compelling statement from the summary report:

[T]he real-world experience of raising taxes on those with higher incomes in the 1990s and cutting them in the 2000s strongly supports the view that higher taxes for those at the top – in the range seen in the United State in recent decades – don’t depress growth, and lower taxes don’t spur it.  In 1993 when President Bill Clinton raised taxes on the top income earners, his opponents argued loudly that such tax hikes would mean economic decline, with some even promising lower tax revenues as a result.  Needless to say, they were proven wrong in spectacular fashion with the longest period of economic growth in US history, increased business investment, 23 million jobs added, and, of course, budget surpluses.  Eight years later, President Bush promised that his tax cuts would spark an economic boom.  That boom never materialized, but renewed large deficits did.  In addition to the clear historical record, study after study has found no relationship between deficit-financed tax cuts and economic growth.

 

On the other hand, here’s some things I don’t like or don’t understand well enough from the CAP proposals on spending to find credible:

  1. They rely on a series of health care delivery reforms for fiscal savings.  I’ve heard that one before.  I’m calling BS on that one.
  2. They rely on lowering drug costs and Medicare payments for savings.  I’ve heard that one before too.  If it was easy they’d have done it by now.
  3. They propose $100 Billion in savings from nondiscretionary programs.  “Non-discretionary” to me implies that somebody is going to squeal very loudly when you try to save $100 Billion on their particular non-discretionary item.  I’m seeing a political hot mess.
  4. They propose $300 Billion in new “job creation” spending by the Federal Government.  Hey guys?  Now you’re just opening yourselves up to being accused of typical lefty Democratic thinking.  Just stop it.

In sum, I like the tax side of this CAP Report, and either can’t agree or remain skeptical of the spending side of the CAP Report.  But hey it’s a start.



[1] Which is a reminder of the enraging fact that only 12 years ago the big problem was figuring out what to do with the expected fiscal surpluses we’d have by 2012.

[2] And the world didn’t end

[3] And again, the world didn’t end

[4] A helpful reminder of why this is, from their report: A high earner who pays $10K in mortgage interest could potentially deduct $3,500, while a low earner who pays $10K in mortgage interest could potentially deduct only $1,500.  They both paid $10K in mortgage interest over the year, but the higher earner gets a much better deal on the deduction

[5] In other words, eliminating the AMT could greatly increase the # of folks who could file their own taxes.  Which seems like a good idea to me.

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SHHHHHH…Please Don’t Talk About My Tax Loophole

I wrote last week that one of the great lessons of the recent Presidential campaign, for me, is how little we as a country understand income tax policy.

Since we’re about to engage in a crash course in fiscal policy[1] it’s worth focusing on the loophole of carried interest.

Both Presidential candidates referred in the debates to closing income tax loopholes, yet both were deathly afraid of mentioning anything specific, such as the egregious carried interest income tax loophole for hedge funds and private equity funds.  Romney skipped it because his entire Bain Capital career benefitted from it, and Obama skipped it because he’s derived a healthy portion of campaign funding from the same industry.[2]

Industry-specific loopholes like this always prove notoriously difficult to close, because benefits accrue to an intensely interested, knowledgeable, and well funded group, while the general public has minimal to no knowledge of the loophole, no voice at the table, and only earns a very diffuse benefit by closing the loophole.

If you don’t know what carried interest is, then you’re not particularly close to anyone in the hedge fund or private equity world.  Frankly, that is the way we in the investment world would like to keep things.  You – in the dark.  Us – avoiding taxes.

However, as a recovering fund manager dedicated to a fearless moral inventory of all things financial, I’ll explain what you’ve been missing by telling my story.

How I tried, ignorantly, to forgo my right to an awesome loophole

When I set up my private limited investment partnership – also called, inaccurately, a hedge fund[3] – my attorney insisted I set up not one additional Limited Liability Company in Delaware, but rather two.  I tried to resist him, saying I felt most comfortable with just one new business entity.[4]  I was so averse to two new entities that I asked another attorney for a second opinion.  He told me the same thing.  I needed two entities.  I asked my accountant.  His response was, of course, “two entities,” and complete puzzlement at my resistance.  Clearly, they knew something that I didn’t.  That something is the awesomeness of the carried interest loophole.  Needless to say, I got the extra LLC.[5]

Two types of income require two entities

Why did my attorney and accountant insist I create a separate entity?  Because that separate entity can collect payments in the form of ‘incentive allocation,’ also known as ‘carried interest,’ which is taxed advantageously, at the same rate as long-term capital gains[6] rather than as ordinary income.  Here’s how it works.

If you set up a traditional hedge fund[7], first things first: you’ll want to charge the traditional “2/20.”[8] Embedded in this short-hand lingo of “2/20” for hedge fund fees are two types of income.

With the two types of income, you need the two entities to keep the income tracked separately.  Entity #1 collects the “2,” which is taxed like regular business income, and Entity #2 collects the “20,” which collects your totally awesome income at a lower tax rate.

The “2” refers to an annual management fee of 2% of assets under management.  On a small/medium-sized hedge fund of, for example, $500 million under management, you will collect $10 million in management fees per year.  The purpose of this money is to pay for rent, staff, overhead, technology, research – in short all the things you need to do as a fiduciary for the proper care and feeding of the client’s money.  This management fee income will net out with business expenses, and may or may not ever generate “profit” for the manager.  In some fundamental sense, it’s not supposed to generate profit; hedge fund managers are fine earning zero profits from management fees since the $10 million is taxed like ordinary income at 35%, which is, as you know, kinda lame.

The “20” refers to the incentive allocation, meaning specifically that 20% of all annual gains are retained by the manager, in entity #2, as ‘carried interest.’  Here, the hedge fund manager takes full advantage of the loophole.  If the $500 million fund has a gain on investments of 10% this year, fully 20% of the $50 million gain on investments – that is to say $10 million – gets earned by the hedge fund manager’s entity #2 as the ‘incentive allocation’ or ‘carried interest.’

At this point, that ‘carried interest’ gets treated at the rate of capital gains, a 15% tax rate, rather than the 35% taxable rate of ordinary income.  Often, by design, the hedge fund manager leaves the entire 20% incentive allocation inside the fund for it to grow long term.  The manager only owes $1.5 million in taxes (15% of $10 million, at the capital gains tax rate) instead of $3.5 million (35% of $10 million, at the ordinary income tax rate).  As a result of the special tax treatment for ‘carried interest,’ the small/medium hedge fund manager in our example keeps $2 million more than he otherwise would have been entitled to keepThat’s a good deal, for him.

And that’s just one year.

And that’s just for kind of a small hedge fund.

You can imagine the bigger, scale-able results available for when a John Paulson-type fund manager scores  big by shorting the subprime mortgages market in 2007 (probably saved about $740 million in taxes with the loophole) or buying gold in 2010 (probably saved about $980 million in taxes with the loophole)[9]

You can also see why my attorneys and accountant insisted that I set up a separate entity that could take advantage of the tax loophole for carried interest.  My keep-my-life-simple approach made absolutely no sense in the face of potential millions in tax savings year after year.  And they knew that.

Is carried interest deserving of special treatment?

Is there anything special about ‘carried interest’ that justifies the preferred tax treatment?

Proponents argue that because much of ‘carried interest’ stays invested inside of hedge funds, still at a risk of loss, that additional risk justifies the 15% preferred tax rate.

But typically much of that ‘carried interest’ left in the market could be liquidated and taken out by the hedge fund manager anytime.[10]  (You know what else is risky?  Having a job, with a salary, that you could be fired from next week, but you have to pay a much higher tax rate on that salary.  That’s pretty risky too.)

Other proponents of ‘carried interest’ argue that tax policy should incentivize the accumulation of our economy’s scarce investment capital, basically the Ed Conard argument for lower taxes on wealth and investments.

In my opinion, that’s bunk.  Capital is not that scarce for any truly innovative segment of the economy.  Most hedge funds and private equity investments offer little value-added as innovative engines of the economy.  I know that’s my hypothesis, not a provable assertion, but I’ve seen enough on the inside to know – these hedge funds are not the engines of innovation you’re looking for.

At the end of the day, the ‘carried interest’ money is treated better than salary money because it’s been earned by a special class of people – hedge fund and private equity fund managers – who are much more influential in the political process than the average worker.  Full stop.

All of this is why I wrote last week that I would appreciate it if both sides of the political aisle would just stop lying to us about fiscal policy and loopholes and treat us like adults.  I’m ready to be pleasantly surprised.  But I’m not going to turn blue holding my breath.



[1] Thanks to the overheated discussion of a completely politically synthetically created crisis known as the Fiscal Cliff.

[2] Don’t be overly misled by some of the anti-Obama rhetoric from titans of the hedge fund industry like Omega’s Leon Cooperman.  Despite Cooperman’s choice comparisons to Nazism, or Dan Loeb saying Obama’s treats them like ‘battered wives,’ hedge fund and private equity managers know that Obama’s been all talk and no action when it comes to what they really care about.  Which is the carried interest loophole.

[3] A pet peeve of mine as well as for many people in the industry, the use of the term ‘hedge fund’ to describe what is better described as a ‘private investment limited partnership.’  ‘Hedge fund’ implies something that has no relation to my business.  I did no hedging.

[4] My reason at the time was that as a small business, I wanted to keep things simple.  A new entity meant the additional cost of entity creation and maintenance, a separate set of accounting books, a separate set of tax returns, etc.  Boy was I wrong about the potential costs and benefits, as I’ll explain below.

[5] Here’s a handy rule of thumb for non-financial people:  Whenever you see a company or business situation with lots and lots of separate business entities, you can be confident there’s tax avoidance going on.  It’s possible there’s also an attempt to shield the principals from bankruptcy, but it’s either that, or tax avoidance.  Anyway, just an FYI.

[6] See my earlier posting on tax rates for different types of income.

[7] Or private equity fund, but for the purposes of this illustration I’ll just refer to a ‘hedge fund.’

[8] Industry folks, bear with me, as you already know this, but the non-financial types don’t:  Insiders refer to hedge funds not as an asset class but as a compensation scheme.  The “2/20” is why.

[9] I’m assuming his reported gains of $3.7Billion and $4.9 Billion respectively, the largest portion of which would be in the form of tax-advantaged incentive allocation.

[10] Admitedly less so for a private equity manager, whose investments tend to be less liquid.

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