Pension funding relief, carried interest tax in compromise bill

Democratic House and Senate leaders on Thursday announced a plan to include pension funding relief in a compromise tax bill that also would include a scaled-down version of increased taxes on buyout funds and other investment managers.

The compromise bill could be voted on by the House as soon as Friday.

The compromise legislation, dubbed The American Jobs and Closing Tax Loopholes Act of 2010, had not been officially introduced, and a text of the legislation was not immediately available.

According to a summary of the bill included in a news release issued Thursday, the funding relief provisions would allow defined benefit plans to stretch out amortization periods for investment losses for two of the years between 2008 and 2011 and over a period of either 15 years or nine years, at the plan sponsor's discretion. The release was issued by House Ways and Means Committee Chairman Sander Levin, D-Mich., and Senate Finance Committee Chairman Max Baucus, D-Mont., which stated that the bill would be introduced Thursday.

Current law requires plans to amortize their investment losses over seven years.

“The plan's funding obligation for a plan year is increased if the sponsoring employer makes excessive employee or shareholder payments,” the summary added.

Pension industry officials warned that it is unclear what provisions are actually in the bill until the text of the legislation is officially released. “So far the details are not available,” said Judy Schub, managing director of the Committee on Investment of Employee Benefit Assets. “So it's hard to know what is and what is not in the bill.”

Also in the legislation, managers of investment partnerships would have to pay a higher tax on carried interest that “does not reflect a return on invested capital,” according to the bill summary. The carried interest from investment partnerships is now taxed as a capital gain at 15%.

“To the extent that carried interest does not reflect a return on invested capital, the bill would require investment fund managers to treat 75% of the remaining carried interest as ordinary income,” the bill summary said.

While the summary didn't say when the higher tax would go into effect, the compromise would mean that carried interest would be taxed at a 30% effective rate this year and 34.7% next year, said Steven Schneider, a tax lawyer at Goulston & Storrs. With self-employment taxes, the rate would be higher — 32.2% in 2010 and 36.9% in 2011.

Carried interest that reflects return on invested capital would continue to be taxed at capital gains rates, currently at 15%.

The proposed tax increase wouldn't go as far as the one approved in December by the U.S. House when lawmakers voted to end entirely fund managers' ability to pay the lower capital-gains rate on the share of fund profits they are paid as compensation.

Mark Heesen, president of the National Venture Capital Association, said in a news release that the carried interest legislation would more than double the taxes venture capital partners currently pay.

“While this provision is movement away from a pure change to ordinary income, evidencing a House recognition that this type of long-term investment is critical to U.S. economic growth, it by no means creates enough of a differential to continue to encourage long-term investment in America's start-up companies,” Mr. Heesen said in the news release. “We hope that this provision can be amended so that there is a meaningful differential — and a real incentive for venture investors to work with entrepreneurs to continue to build America's next generation of employers.”

Bloomberg contributed to this story.