Private Equity's Real Tax Loophole Being Missed: Street Whispers

NEW YORK (TheStreet) -- A controversial tax loophole for investment managers is expected to be removed by President Obama if he wins the election, but one tax consultant has another idea.

At issue is the so-called "carried interest" loophole, which allows investment managers to pay just a 15% capital gains tax on an important part of their compensation, as opposed to the standard 35% income tax rate.

Investment managers are compensated in part via a share of profits they make by investing their clients' money. Because those earnings come from investments, they are taxed as capital gains.

However, opponents of the loophole, such as House Ways and Means Committee Ranking Member Sander Levin (D., MI), argue this is unfair.

"There is absolutely no reason why income earned for managing other people's money shouldn't be taxed in the same way as income earned teaching or working in a factory. This loophole for years has unfairly enabled some of the highest-paid individuals in the country to sharply reduce their tax bills and it is time to close it once and for all," Levin wrote in an emailed statement sent by his spokesman.

However, tax consultant Robert Willens, head of Robert Willens LLC, and a self-described "tax purist," fears closing this loophole will just further complicate the tax code, because it will mean that "partners in investment management partnerships somehow have ordinary income rather than capital gains even though the partnership is earning capital gains," as Willens puts it.

Instead, Willens believes new partners who receive a partnership interest in a firm should be taxed at that time at the 35% rate. Currently, they aren't taxed at all because the Internal Revenue Service decided that valuing that interest is too difficult.

The issue may be moot if Romney wins the White House. And the Buffett Rule, which, according to the White House website, consists of the "simple principle" that "no household making more than a $1 million should pay a smaller share of their income in taxes than middle-class families pay," may find a different way of addressing the issue.

-- Written by Dan Freed in New York.

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