Carried interest issues

Reader comment on: Kristof, Taxes and Billionaires

Submitted by G. Thompson (United States), Jul 8, 2011 14:10

Thanks for the pointers to your earlier article. It helped me see the situation in a more balance way. I still think there needs to be some sort of reform here though.

It should be noted that "Deferred Compensation" plans gets taxed as ordinary income when the proceeds are finally taken out and it is effectively the same as the "retained interest" situation. What's more, there is no downside protection.

The question is how to value "sweat equity" when it is taken in lieu of ordinary income as a "retained interest"?

At some point it "should" be valued and taxed as ordinary income. (You would then pay the ordinary income tax on it and thereafter it would be capital gains) Taxing the value of it at creation (or shortly thereafter) is a problem as it doesn't have established or earned value yet (vested or not?) AND its market value may not yet be established on the open market (It could possibly be valued by the other investors. i.e. what they value by their investment $$ vs share of the business that they take).

Clearly there needs to be some tax advantage somewhere as there is a risk factor vs. taking a salary. The issue is how the fed can determine an ordinary income amount on which to exert the tax. The flip side if the "retained interest" was finally sold at below the ordinary income amount, you would be able to take a loss.

There are legitimate issues here (As to the risk of putting sweat equity into a cash-poor startup). On the other hand, a whole financial services industry has grown up that exploits this feature and is geared to minimum risk. It isn't clear that society is reaping sufficient reward for the tax advantage given in the financial services arena. For example, in a manufacturing start-up, the founders sweat-equity tends to go more directly to job creation.

---

Note: Comments are moderated by the editor and are subject to editing.

Submit a comment on this article

Other reader comments on this item

Title	By	Date
⇒ Carried interest issues [319 words]	G. Thompson	Jul 8, 2011 14:10
Poor logic [152 words]	John	Jul 7, 2011 22:48
Easy logic [w/response] [87 words]	Andy	Jul 7, 2011 14:44
Another loophole to close. [90 words]	Lyle	Jul 7, 2011 14:17
absurd [202 words]	Teo	Jul 7, 2011 13:34
incentives [73 words]	Jonathan N	Jul 7, 2011 12:01

Comment on this item