For now, the private equity industry has dodged the “carried interest” bullet.

House Ways and Means Committee Chairman Charles Rangel, a New York Democrat, on Thursday said he is working on a temporary Alternative Minimum Tax relief bill that would drop the private equity and hedge fund carried interest provisions and use less controversial measures to cover the cost of extending AMT relief.

Carried interest, to review, is the profits private investment firms earn when they sell a company or any of their assets. In the typical private equity firm structure, for example, they keep 20 percent of the carried interest and give the rest to their investors.
Okay, so with that being a significant income stream for a private investment fund, you’d think that Uncle Sam charges them the 35 percent ordinary income tax rate. Not so.

They’re charged at the 15 percent capital gains rate. And therein lies the rub. Unions and politicians seized on the issue when it became clear to the public just how rich the private equity/hedge fund industry had become. Stephen Schwartzman’s quick leap to a $7 billion man was the last straw before Congress acted to take on carried interest, and try to get the firms to pay the 35 percent tax rate on profits.

Some called this the “war on prosperity.” But even private equity executives themselves called it common sense. For years, the buyout industry operated under the radar. It was a “dirty secret” that they paid capital gains on profits. 

Some private equity executives have defended the capital gains rate passionately, saying that its premise is to reward risk takers that, in the entrepreneurial spirit of capitalism, are willing to invest capital to create economic growth.

But opponents point out that the capital being invested is mainly other people’s money, namely institutional investors. So is private equity investing entrepreneurial, or just one heck of a way to make money, thanks in part to a low tax rate.

The PE firms’ defense of the carried interest rate lost some of its luster when a study came out that said most firms make most of their money off of fees, not carried interest. Fees earned by buyout firms are charged an ordinary interest rate, in most cases.

The bottom line, most private equity honchos interviewed by Reuters have said raising the carried interest tax rate really wouldn’t have a big impact on them, nor their institutional investors. For some smaller private investment firms, sure. But for the most part, jacking up the tax rate was a pain in the neck as opposed to a death knell.

Whether or not the issue will return to the Congressional calendar is up to lawmakers. But surely the private equity industry, and its intense lobbying effort, is pleased to have the issue on the backburner for now.

As for the industry’s critics, the tax rate will remain a sticking point–a loop hole they believe is open only to the richest Americans.

(Photo. Charles Rangel, Reuters file)