Obama’s deficit plan hikes tax on carried interest for VCs, hedge funds

As part of his strategy for reigning in the federal deficit, president Barack Obama plans to raise taxes on carried interest for a wide range of hedge funds and private equity managers, according to officials within the administration. The rate would jump from 15 percent (the usual for capital gains) to the income tax rate of 35 percent, more than doubling the tax investors pay on most of their income. Carried interest can briefly be defined as interest earned on profits from investments (typically 20 to 25 percent), and is largely used to pay general partners at firms.

In this case, private equity includes venture capital. So Silicon Valley’s venture capitalists are included in the group who will pay more taxes under the plan. Back in 2007, VentureBeat editor Matt Marshall endorsed raising the rates.

It’s definitely not a novel idea. Just last year, the House of Representatives approved a bill that would have upped taxes on carried interest, but it was killed in the Senate. Still, this new plan seems to have caught the private equity community by surprise. Many predicted that Obama would level his sights on more pressing problems, considering the drop in taxable profits, according to the Wall Street Journal.

But Obama means business. He recently announced his goal to slash the $1.3 trillion deficit in half (to $533 billion) within the next four years. Certainly, his very expensive economic stimulus package isn’t helping. But he seems confident that raising taxes for those who make more than $250,000 a year (including many hedge funders) — in addition to dialing down spending in Iraq — could go a long way toward closing the gap.

While both Democrats and Republicans opposed a tax increase on carried interest in past years, the loss of credibility on Wall Street has turned executive compensation into a ripe political target. No one anticipates major roadblocks for the plan.

A quick explanation of carried interest, below: