Tax plan doesn't mention it, but Trump still 'committed' to ending a loophole for the rich

Key Points
  • President Donald Trump campaigned on many promises, among them a demand that hedge funds pay their share of taxes.
  • Carried interest, which refers to the lower rate assessed on long-term investments, has been a subject of tax reform debates since the campaign.
  • The GOP tax plan doesn't mention carried interest, but it does seek to lower the maximum rate on partnerships, sole proprietorships and other small businesses to 25 percent.
White House advisor Gary Cohn: Twenty-percent corporate tax is a 'bright-line' test
White House advisor Gary Cohn: Twenty-percent corporate tax is a 'bright-line' test

President Donald Trump's top economic advisor said Thursday the administration remains committed to killing a tax perk that would hit certain corners of Wall Street in the pocketbook, even though it wasn't mentioned in the GOP tax plan.

"The president remains committed to ending the carried interest deduction," Gary Cohn, director of the National Economic Council, said on CNBC.

Carried interest is the profit hedge funds, private equity funds and other investment managers make for managing investments. Usually they charge 20 percent of gains in their funds in any given year on top of a 2 percent annual management fee they get regardless of performance. According to Institutional Investor's Alpha magazine, the top 25 hedge funds made $11 billion in profit last year.

For investments held for more than one year, profit is taxed at the lower capital gains rate of 23.8 percent, not the ordinary income rate of 39.6 percent. Profitable investments held less than one year are short-term gains taxed as ordinary income. And here's the trick: Hedge funds dodge in and out of investments and, unlike private equity funds, typically don't take controlling stakes and don't hold investments for years.

Gary Cohn
David Paul Morris | Bloomberg | Getty Images

Some have said hedge funds aren't worried about losing carried interest because it doesn't really affect them. "It's well known that hedge funds don't benefit from carried interest," said Robert Willens, a tax and accounting advisor.

Trump campaigned on many promises, among them a demand that hedge funds pay their share of taxes, saying they are "getting away with murder."

Earlier this month, Treasury Secretary Steven Mnuchin, a former hedge fund manager and like Cohn a former Goldman Sachs executive, said carried interest may be preserved for companies or "other entities that create jobs."

Here's where the nine-page tax reform framework released on Wednesday may actually help hedge funds, though: It doesn't mention carried interest. Instead, the outline focused on narrowing the number of tax brackets and raising standard deductions for individual filers, cutting the corporate tax rate and bringing corporate profits held overseas back to the United States. It would end the individual deduction for state and local taxes.

But it also proposes a 25 percent maximum tax rate for sole proprietorships, partnerships and other small or family-owned businesses, a definition that could apply to hedge funds and other professional services firms, Willens said.

Ending the individual tax deduction for local and state taxes would hit affluent taxpayers in states like New York and New Jersey hard. But significantly lowering the rate on partnerships and other small or family-run businesses (aka, a lot of hedge fund managers) could be a profitable tradeoff.

"I would be more than happy to trade the local and state tax deduction for the lower pass-through rate," Willens said. (He noted that his consulting firm would benefit.)

Asked about carried interest on CNBC's "Squawk Box" on Thursday, Cohn said: "As we continue to evolve on the framework, the president has made it clear to the tax writers and the Congress that that is his position. That was his position during the campaign and he continues to support the position that carried interest is one of those loopholes that we talk about when we talk about getting rid of loopholes that affect wealthy Americans."