The conflict over tax relief for investors is intensifying. Business owners should be aware
“Deferred interest” tax relief is once again the subject of fierce debate, and business leaders could feel the effects.
The $ 3.5 trillion budget reconciliation bill, which is still under preparation in Congress, could target deferred interest, which is a common way for venture capitalists, private equity partners and hedge fund managers to receive compensation. It allows these investors or managers to share the profits of their funds at a reduced tax rate. These profits are now taxed at the maximum long-term capital gains rate of 20% plus a net investment income tax of 3.8%, rather than ordinary income, which is subject to a maximum rate of 37%.
President Biden and many congressional lawmakers have called for the elimination of the deferral interest tax relief in the budget deal. General partners and investors would still make profits from their businesses, but they would be taxed at a much higher rate. This could generate $ 16 billion over 10 years, according to an estimate by the Joint Committee on Taxation.
In a statement, Senate Finance Committee Chairman Ron Wyden (D-OR) called the benefit “one of the tax code’s most indefensible loopholes.”
Those who support maintaining the status quo argue that this is fair tax relief given the high-risk nature of entrepreneurial investing. Ending the tax break, they say, would divert money from startups and other job-creating investments.
On Tuesday, the United States Chamber of Commerce, a business advocacy organization, released a study claiming that one of Biden’s proposed tax changes would force affected industries such as real estate and private equity to downsize, cut 4.9 million jobs, hurt businesses pension returns and unfairly sanctioning industries that invest in areas such as sustainability and health.
“The impact … would be widely felt across the economy because of the deterrent effect it will have on investment activity,” the organization wrote in a press release.
Some of the assumptions in the House inquiry are a bit “out of the way,” according to Jeffrey Sohl, professor of entrepreneurship and decision science at New Haven University.
“If this goes into effect, will the venture capital industry cease to exist? I don’t think so,” Sohl said.
Removing or changing interest has been a topic of discussion among lawmakers at least since the days of the Dodd-Frank law on Wall Street reform and consumer protection, which was passed as a result of the 2008 financial crisis, adds Sohl. With Democrats in control of the reconciliation process, it’s likely that interest will suffer, even if it makes exceptions for things like impact investing.
But the possibility of a drastic change worries some investors. Mac Conwell, who runs Baltimore-based RareBreed Ventures, says the loss of deferred interest would slow the growth of his relatively new company. Much of the profit he earns from deferred interest goes directly back to the fund, he says, which would limit the number of startups the company could help.
Moreover, he fears that the tax will simply mean less money for the founders, making venture capital funding even less fair. “The founders who are going to hit the hardest are underrepresented,” he says.
Small investment firms like Conwell are being overlooked in political debates over this tax hike, says Brett Palmer, chairman of the Small Business Investor Alliance (SBIA), a professional association of private equity and venture capital funds . By the logic that small investment firms will invest in small firms, less money for those firms means less investment in small and medium sized firms, he says.
Sohl agrees that a change in the law wouldn’t mean as much for the bigger players. “The first funds affected by this will not be the Andreessen Horowitzes,” he said.
Many other tax changes are being studied under the budget reconciliation bill, including some for intermediary businesses. The bill could pass without the support of Republicans, but would require a near unified front of Democrats.