Living in Central Massachusetts, had I the vision of Sarah Palin, who can see Russia from her home in Alaska, I could look north and see New Hampshire on the right and Vermont on the left. It is perhaps an apt metaphor. New Hampshire with its "Live Free Or Die" license plate, apparently made by prisoners, go figure, has an overrated reputation as a tax haven, thanks to the lack of income tax on wages. More to the point, there is the Free State Project that promises to turn New Hampshire into a libertarian paradise with a little bit of help from the Koch brothers. Vermont, on the other hand, has Bernie Sanders, who calls himself a socialist. Anyway, Bernie Sanders has started a bit of flap by with a letter recommending that the President take executive action to raise taxes by closing loopholes.
During the last year Presidential election carried interest was in the fore, because it was something that Mitt Romney had used to keep his taxes low. The discussion about attacking carried interest with regulation was a staple of my blog during that period, as I considered the President kind of hypocritical for not doing that and also thought that the proposed legislation to address the issue was really awful. At any rate here is how carried interest could be easily addressed by regulation.
There is, however, an approach that could end the benefit without adding three thousand words to the Code. It does not require the cooperation of Congress. There is a regulation 1.701-2 that governs using the partnership form in a way that is inconsistent with its purpose to:
"permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity-level tax"
The regulation goes on to list good and bad reasons for using the partnership form. Venture capital funds and hedge funds do not have to be organized as partnerships in order to do what they do. You could have some sort of co-ownership. Frequently people prefer co-ownerships, since they can often be simpler. Why do venture capital funds and hedge funds organize as partnerships ? Well one reason is so that the managers can get captial gains treatment on their incentive compensation. If that is not a good reason, the IRS can add it to the “bad partnership” list and it is done.