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carried interest is a share of a partnership's profits that is taxed as a capital gain as opposed to ordinary income. It is a good deal: The top rate on gains held longer than a year is 15%, so the tax on carried interest is usually less than half the top 35% rate on ordinary income. There aren't FICA or Medicare taxes, either.
Here is how carried interest works: Say Ted and Joe set up a private-equity fund together. They organize it as a partnership in which they are "general partners" who manage the fund, while their investors are "limited partners." ("Limited" means the investors can't lose more than they put in and aren't in charge.) There isn't a layer of corporate taxes, so profits and losses flow directly through to all partners' personal tax returns.
The typical fees charged by these funds are known as "2 and 20"an amount equal to 2% of the fund's assets plus 20% of its profits.
Organizers like Ted and Joe typically claim the 2% fee as compensation, so it is subject to ordinary-income and payroll taxes. But they usually classify the 20% share of profitswhere the big money can beas an investment that produces a capital gain or loss. ...
Now there is an important voice siding with the skepticsthe Tax Court's. (The Tax Court is a national court devoted only to tax cases where taxpayers needn't pay disputed levies up front.) The ruling in Dagres v. Commissioner wasn't directly about carried interest but contains an important ruling on it that experts are now parsing.
Venture-capital-fund manager Todd Dagres wound up in court over a $3.6 million deduction he took for a loan to a business associate that went sour. From 1999 through 2003, Mr. Dagres earned $10.9 million in compensation and $43.4 million in capital gains from carried interest.
The case hinged in part on whether Mr. Dagres's share of profits meant he was engaged in a trade or business, or was acting as an investor. The Internal Revenue Service said he was an investor, but in late March the Tax Court disagreed and allowed Mr. Dagres to have his deduction because his carried interest was compensation from a trade or business.
Wrote Judge David Gustafson: "Neither the contingent nature of [Mr. Dagres's carried interest] nor its treatment as capital gain makes it any less compensation for services." The opinion also likened his business to that of "stockbrokers, financial planners, investment bankers, business promoters, and dealers"all of whom pay taxes on their income at rates up to 35%.
I'm beginning to think that manuipulating money is a profession that is older than prostitution but not quite as honorable.
One has to wonder if taxing all capital gains at regular rates
would be a good idea at this time
Not sure about the specifics of the Dagres case but as I recall, partners file partnership returns and their individual incomes are carried over to the 1040. Those incomes, which include profits, are subject to the Self Employment Tax which in itself takes a hefty bite.
What crap. Like the money manages itself and the gains just appear out of thin air.
It should be a capital gain.
There's no way for retail investors to short hedge funds or profit from their losses. But there are seemingly limitless ways to get burned by the industry's omnipresence throughout the financial system. Hedge funds now manage $2.04 trillion globally. That's the most amount of money ever in the industry's history, according to Hedge Fund Research's June 30 figures. "Because hedge funds are expected and incentivized to take on a broad variety of risks, they can get killed during bad times from market turmoil and dislocation," says Andrew Lo, the director of MIT's Laboratory for Financial Engineering. "They're tremendously valuable as early warning indicators of oncoming distress."
Overall hedge fund performance has mimicked drops in the equity markets. The Dow Jones Credit Suisse Core Hedge Fund Index was down 3.76% as of August 31 compared to a 3.1% drop in the S&P 500 index. But many prominent hedge funds have done much worse than the broader market. Lyxor Asset Management, an arm of French bank Societe General, feeds $11.7 billion from investors into 100 hedge funds through its managed accounts platform, according to Stefan Keller, head of research and external relations at Lyxor. According to documents obtained by CNNMoney, 15 of these funds generated double digit percentage losses as of September 2. Five funds were down more than 20%.
Lyxor does not make these returns public and did not provide these documents to CNNMoney. According to Lyxor's data, the five funds that generated the largest losses so far in 2011 employed different strategies: Altis Partner's "Altis Fund" fell 21.91% as of September 2 and mainly purchased commodity futures. Two event-driven and risk arbitrage firms, London's Altima Partners "Global Special Situations Fund" and John Paulson's "Advantage Fund Limited" dropped 24.92% and 23.86% respectively. Mount Lucas Partners' MLM Fund dropped 25.67% and employs a macro strategy, meaning that it can jump into any type of situation or asset class that appears undervalued. CRM Windringe, a more traditional hedge fund that buys long positions in stocks and hedges with some short positions, fell 24.22%.
Representatives from Altis and CRM Windringe declined to comment on their returns. Altima Partners, Paulson & Co. and Mount Lucas Partners did not return calls for comment. However, the returns generated on Lyxor's managed account platform need to be taken with a grain of salt. They do not always correlate with the hedge funds' overall returns and often are just a small fraction of a hedge fund's managed assets. Lyxor puts more restrictive terms on the management of the account.
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