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IRS will ban hedge fund tax loophole on carried interest, Mnuchin says

IRS will ban hedge fund tax loophole on carried interest, Mnuchin says
Treasury Secretary Steven Mnuchin testifies before the Senate Finance Committee on Feb. 14. (Susan Walsh / Associated Press)

Treasury Secretary Steven Mnuchin said the Internal Revenue Service will issue guidance within the next two weeks to prevent hedge fund managers from dodging new tax rules on carried-interest profits.

"I've already met with the IRS and our Office of Tax Policy this morning as a result of that article," Mnuchin said Wednesday during a Senate Finance Committee hearing, referring to a Bloomberg News story about hedge fund managers creating shell companies to work around stricter limits on carried interest. "Taxpayers will not be able to get that loophole."

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Mnuchin's comments were in response to questions from Sen. Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee. Wyden called the new tax law requiring managers to hold assets for three years instead of one year to qualify for the lower tax rate a "farce."

Carried interest is the portion of an investment fund's returns that are paid to hedge fund managers, private-equity players, venture capitalists and certain real estate investors. For federal tax purposes, it's eligible for a tax rate of 23.8% — which includes a 3.8% tax on investment income imposed by the Affordable Care Act — on sales of assets held for at least three years. Otherwise, it's treated as ordinary income and managers face a top federal income tax rate of 37%.

Big names have appeared to be embracing the maneuver, which requires setting up limited liability companies, or LLCs, for managers entitled to share carried-interest payouts. Four LLCs have been created under the name of Elliott Management Corp., the hedge fund giant run by Paul Singer. More than 70 have been established under the names of executives at Starwood Capital Group Management, the private-equity shop headed by Barry Sternlicht.

Epstein and Weiss write for Bloomberg.

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