Venture Capitalists Fight Tax Hike on Carried Interest

Venture capitalists are fighting a bill, introduced in the House of Representatives recently, that would sharply increase the taxes they pay.

The bill, the American Jobs and Closing Tax Loopholes Act of 2010, would, among other things,

increase taxes paid by investment fund managers on carried interest, which is how venture capitalists make most of their money.

Venture capitalists are fighting a bill, introduced in the House of Representatives recently, that would sharply increase the taxes they pay.

The bill, the American Jobs and Closing Tax Loopholes Act of 2010, would, among other things,

increase taxes paid by investment fund managers on carried interest, which is how venture capitalists make most of their money.

Carried interest, known in the industry as “carry,” is the venture capitalists’ share of the profits after a start-up goes public or is sold to a bigger company.

A typical firm collects management fees of 2 percent of the capital it is investing, and 20 percent of the profits from a successful investment.

Today, carry is taxed at the capital gains tax rate of 15 percent, set to increase to 20 percent next year.

Capital gains are defined as the gains from an investment after it is sold at a higher price, and the tax rate is low to encourage risky entrepreneurship and investment.

But some legislators have argued that investing other people’s money, as opposed to the venture capitalists’ own money, is not that risky.

The carry earned that way, they say, should be taxed at the much higher rate of ordinary income, just like wages.

Some venture capitalists agree that the tax rate should be changed, according to this article in the New York Times.

In a controversial blog post a few years ago, Fred Wilson of Union Square Ventures argued that venture capitalists should pay higher taxes on carried interest when they are investing other people’s money.

“That is a fee you are being paid and it should be taxed as ordinary income,” he wrote. “I really don’t see how anyone can argue otherwise with a straight face.”

The new bill would require that 25 percent of investment managers’ carried interest be taxed as capital gains and 75 percent as ordinary income.

That would work out to be a tax rate of about 35 percent, according to the National Venture Capital Association.

“It’s going to discourage people from going into venture and it’s going to discourage long-term investing at a time when it’s exactly what we want people to do,” said Kate Mitchell, a managing director at Scale Venture Partners.

Venture investing requires taking a risk on an idea and then working closely with the entrepreneurs over a decade, she said.

If the returns are taxed as ordinary income, she is worried that smart investors will choose other places to work, like hedge funds, that promise faster returns but do not create new companies or jobs.

Calling the new bill a jobs bill “is ironic, as doubling the taxes on job creators will result in less jobs, not more,” said Mark Heesen, president of the association, in a statement.

In the first three months of the year, venture-backed start-ups added more than 13,000 jobs, according to the association and StartUpHire.com.

This fight boils over every so often in the House, but the Senate has never agreed to change the way that carried interest is taxed.

Emily Mendell, a spokeswoman for the association, which lobbies on behalf of the industry, said the group hoped that even if the bill passed in the House, the language would be changed in the Senate version.

“In the Senate, there’s a group that understands there is importance in long-term investment, and we’re hopeful they’ll draft their bill to reflect that,” she said.