Debate Recap: What the Heck Is Carried Interest?

clinton-trump-carried-interest

Eliminating “carried interest” was something that came up a few times during Sunday night’s debate between presidential candidates Donald Trump and Secretary Hillary Clinton.

When Trump was asked what specific tax provisions he would change to ensure the wealthiest Americans pay their fair share in taxes, he responded that he’d get rid of carried interest, but lower the tax rate for those in the higher earning percentiles from 35% to 15%.

And Secretary Clinton responded later, “I’ve been in favor of getting rid of carried interest for years, starting when I was a senator from New York.”

So what the heck is carried interest? And would eliminating it really “ensure that wealthy Americans pay their fair share?”

Defined

Carried interest is essentially a share of the profits from investment funds that is generally treated as capital gains for tax purposes. That means this income gets taxed at a much lower tax rate (up to 25%). Carried interest typically is given to general partners of investment funds, who receive it in exchange for managing a profitable fund, according the Tax Policy Center.

According to the Center, some argue that that carried interest should be taxed at the 39% income tax bracket. Others argue that these fund managers take risks, just as entrepreneurs do, so they should be able to take advantage of the lower tax rates for capital investments. Still others defend the status quo, saying that corporate income already faces an unfair double taxation (saying that C corporations are subject to corporate taxes and individual income taxes when realized or distributed.)

The Heart of the Debate

“We’re just debating the characterization of that income,” says Martin Cantor, CPA and director, Long Island Center for Socio Economic Policy. “Is it capital gain income (and taxed lower) because it’s generated from an investment? Hedge fund managers say yes. Others say no, it should be characterized as earned income as a bonus for doing well. And that would be taxed at 39%. Those who are not making the money feel they should be paying more.”

Politicians are playing to the crowd during election season and when the crowd cries that the rich people are getting richer, they might not be taking into account that they’re getting richer because they’re taking big risks, explained Cantor.

“Some would say it’s their bonus over and above their salaries for making good investment decisions for all the investors, so it should be different,” says Cantor.

“This country is great because of capitalism,” said Cantor. “The fact of the matter is, we’re built on people who invest money and take risks for the profit motive. And if they take those risks, they get rewarded by having more income.”

But What Affect Would It Have if it Were Eliminated?

Taxing the carried interest as ordinary income wouldn’t generate a huge sum for the tax base, according to the Tax Foundation. It would raise $15 billion over the next decade, on a static basis.

“Carried interest represents only a very small portion of all employee compensation. Thus, the economic impacts of this tax change would be small,” according to the Tax Foundation website. However, the Tax Foundation also found that eliminating it could result in a net loss of 2,200 jobs.

The politicians didn’t talk about the rising debt levels of the average American household, whether people can afford their mortgages, or even the growing problem of identity theft. That doesn’t mean you should be ignoring how these issues can impact your personal financial situation by implementing good budgeting methods and not falling into debt. You can stay on track by getting a snapshot summary of your credit report, updated every 14 days, on Credit.com.

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