Friday, September 16, 2011

Its Baaaaaaack! The American Jobs Act of 2011 Proposes to repeal capital gains treatment for Carried Interest in funds

Many readers will recall the battle preceding the passage of the Dodd-Frank Act where the fund world fought a proposal to tax carried interest as ordinary income rather than as capital gains, which is currently the law. A collective sigh of relief was heard from venture capital, private equity firms, hedge funds and real estate developers across the US when the proposal didn’t make it into law. The proposal is back and is a hallmark of the American Jobs Act of 2011

Carried Interest (fight back the yawns, people…) is a key source of income to general partners in funds as they participate in earnings (either from profits of the company or exits). It is also a major incentive to perform well because it ties the income of fund managers to the success of the investments made by the fund. The current proposal would eliminate the capital gains treatment of those earnings and would tax them at ordinary income rates because they would be treated as income for services. Ordinary income is subject to rates of up to 35% (39.6% as of 2012) verses 15% for capital gains (20% after 2012). Its easy to see how fund managers and venture capitalists can get wound up, given the spread between the tax rates.

The proposed changes will help fund the Act and which will likely escalate the debate about the interests of employing the unemployed and who will pay for those initiatives.

The irony in the discussion of how to fund employing the unemployed is how government views “job creation.” A significant percentage of entrepreneurs receive funding through investments from angel investors (individuals and funds) and venture capitalists. The National Venture Capital Association cites data suggesting that venture capitalists help create new jobs in critical high tech industries that would not exist without both the financial backing and human capital contributed by venture capitalists.

Through a study back by the NVCA, they found that in 2010:

  • Venture backed companies accounted for 11.9 million US jobs ( out of 107.3 million US private sector jobs) which is equivalent to 21% of US GDP.

  • 10% of total US Sales ($3.1 trillion out of $30 trillion) is venture-backed revenue.

  • $23 billion of capital was injected into the US economy by venture investment into 2,863 companies.

  • The percentages of venture-backed jobs in major industry sectors (90% for software; 74% for biotechnology; 72% for semiconductors and on and on).

It is noteworthy that a significant number of the companies that received venture dollars were not necessarily large companies that already have many employees. Many of the investments were in emerging companies seeking growth capital which has a direct correlation to either hiring employees or hiring third parties (who in turn have employees) to further develop their products and services for the market. Many people equate “venture” with investments in the hundreds of millions of dollars, which in fact is the exception rather than the rule. Venture funding is a the heart of new job creation which is hard to find in other sectors of the economy.

This debate is likely to very quickly get very hot!


  1. I find it ironic that the very policy makers that are positioning themselves as job creators are actually killing job growth. Kermit Nash has hit the nail on the head. Hiding the tax change in the President’s jobs bill is yet another “stealth” way of further adjusting the tax burden onto those that are the most productive in creating jobs. Biotechnology is a significant growth potential area for the U.S. economy; however since 2000 more than 297,000 pharmaceutical jobs have been lost in the U.S. As part of the 2010 Patient Protection and Affordability Act, medical device companies in the U.S. will be taxed an additional 2.3% on revenues. AdvaMed, a respected industry watch dog group estimates that this tax alone will eliminate up to 43,000 private sector jobs in the medical technology field in a few short years. Medical device companies continue to announce workforce reductions through the rest of 2011, 2012 and into 2013 when this tax goes into effect so that medical device companies can pay this tax.
    It is time that we return the U.S. economy to a growth pathway of lower taxes, reasonable regulation and an overall environment that supports growth in the private sector.

  2. Well said. Keep in mind that the tax comes at the back end of innovation, at sales. While capital gains vs. ordinary income would also come at an exit, its those proceeds that are usually reinvested into new funds, new companies and in turn fuel innovation and create jobs.

    The Minneapolis/St. Paul Business Journal stated that Minnesota would lose 2,700 jobs with the medical device tax.