Will 'Carried Interest' Get Carried Away?

Libor…"Fiscal cliff"…business jargon is creeping into a lot of general news headlines these days.

Next up: carried interest.

Will 'Carried Interest' Get Carried Away?
Comstock | Getty Images

Simply put it's the term for the cut a money manager gets for handling investments in vehicles like hedge funds or private equity ventures.

Determining the size of the cut can get complex. And it looks like determining the size of the tax bite out of that income will get complex too as we go barreling toward the cliff.

Historically "carried interest" has been taxed at the same low tax rate as investment income. The idea was the manager's cut was based on underlying risky investments and therefore deserving of a break.

But lately some say that "carried interest" isn't as risky as it appears, since funds usually involve many investors and structures that don't really put the manager's personal investment at risk.

So the investment manager's pay should be taxed at a higher rate, like a sales commission. Indeed many argue the tax rate for investments in general, capital gains, needs to be higher. The other side of the argument is that you need lower tax rates to attract investment capital in the first place.

However that general debate works out, carried interest is likely to attract particular attention and, to the minds of many, particular action.

"There have been a number of proposals gradually to phase it out and bring it up to other high rates over a several-year period," said Wilbur Ross, CEO of Ross & Co., in a recent CNBC interview. "I wouldn't be surprised if something like that happened."

The timing of the debate will be interesting. Stricter rules about how much trading banks can do with their own money are going into effect soon. That's prompting some banks to cut back on market trading operations.

Workers in those areas are widely expected to jump into hedge funds and other types of private investment operations. But if the tax rate is less appealing, will that migration happen?


Allen Wastler is managing editor of CNBC.com. Follow him on Twitter @AWastler. You can catch his commentary on CNBC Radio. And check out his fiction.