How do Hedge Funds pay 15% tax?

Discussion in 'Taxes and Accounting' started by dancalio, Nov 13, 2008.

  1. dancalio


    In the hearrings, they said that the Hedge Fund guys are only paying 15% income tax.

    Could somebody explain exactly how this is?

    (I'm not complaining, I think everybody should have a lower tax rate, I'm just trying to figure out what the true story is)
  2. lassic


    i think there is a loophole that treats their fees as capital gains and not as wages or salary
  3. It is the "carried interest" tax break.
  4. dancalio


    Correct me if I'm wrong....

    They are counting their 20% compensation as long term capital gains, thus the 15% rate. But aren't the majority of hedge fund gains short-term, thus having to pay typical income tax on those gains? What is the trick?
  5. From what I loosely recall, plus what was discussed in the hearing today, whatever the nature of the underlying gain on the investments are (short-term or long-term), the applicable rate is passed on to the carried interest. So if a HF is trading entirely short-term, the carried interest would be taxed at the short-term rate (in the future when the manager withdraws/realizes it). I could be wrong on that, that's just what I gather.

    Griffin and another manager today mentioned how all of their earnings lately were taxed at the higheset rate, which I took as confirming the above, being that they are doing mostly ST trading.

    The debate centers upon the fact that carried interest is compensation, therefore it should never be taxed at the LT rate (even if the underlying gains were LT) nor should it be allowed to be deferred, but changing either would require changing the tax laws for all partnerships entities.
  6. This is a logical assumption, but it's not correct. The real reason for them being taxed at the highest rate is because in the recent revised 'bailout bill', there was a clause snuck in eliminating the 15% cap gains loophole for fund managers. Thus manager payout is now taxed as earned income regardless of investment style.

    And, it's important to specify, that the original 15% tax, was only applicable to hedge fund managers, not the fund itself. The fund itself is not taxed... earnings are passed through to investors/partners like in any partnership.
  7. Daal


    Its amazing how no congressman asked during the entire thing why Soros isn't running a fund domiciled in the US. they kept praising him and meanwhile he got his wealth in tax havens and that cost the treasury billions over the years(this is just an observation, I'm not critizing soros)
  8. dancalio


    Are you sure it's treated as earned income? If earned income, they get extra screwed as they would have to pay 3% medicrap with no limit on top of income tax.

    I'm guessing it gets treated as normal pass-through income from a partnership, which is taxed at the marginal income tax rates, but does not count as employment income.
  9. Thanks for the clarification. I'm quite surprised that wasn't brought up in the hearing yesterday. Their entire discussion on the topic was therefore relatively a moot point as the change had already been made. Odd..

    Prior to the bailout bill, would the carried interest on a fund with only ST trading gains ever be taxed at 15%? It was only applicable to LT gains right?
  10. cane1214


    I believe he contributes a fair share of $ to the democratic party, which may be a reason he wasn't grilled like Griffin was
    #10     Nov 14, 2008