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Tax Reform Bill Leaves Asset Managers Largely Unscathed

The proposed tax plan makes no mention of the carried interest loophole benefiting private equity firms and hedge funds.

  • Alicia McElhaney

President Donald Trump’s tax reform plan isn’t as tough on asset managers as some of the talk indicated it would be.

The bill released Nov. 2 by House Republicans made no mention of closing the carried interest loophole or lowering 401(k) contribution limits, changes that would have cut into profits or slowed their growth. The proposal also lowers the rate on excise taxes paid by private foundations while making some private universities newly subject to them.

If successful, the legislation, which proposes reducing the corporate tax rate to 20 percent, would result in the largest change to the U.S. tax code since 1986. While House Republicans are touting the bill as a boon to the middle class, the overhaul would provide far more benefits to companies and asset managers, according to Eric Hananel, principal at the New York branch of consulting firm UHY Advisors.

“This is a bill that’s very pro-institutional investor,” Hananel said in a phone interview.

Treasury Secretary Steven Mnuchin had signaled in September at the Delivering Alpha conference in New York that hedge funds would lose the benefit of a carried interest loophole under Trump’s tax reform. Carried interest, the cut of profits that private-equity and hedge-fund firms earn from the investments they make, is taxed at a lower rate than ordinary income.

[II Deep Dive: Steven Mnuchin: Hedge Funds Will Lose Tax Benefits]

Closing the carried interest loophole for hedge funds while keeping it for private equity firms would have ended the tax benefit for investors that typically put money to work over the shorter term, according to Jeremy Swan, managing principal at CohnReznick, a tax and business advisory firm.

“The administration’s perspective was that carried interest would be segmented,” said Swan. “The loophole would be retained for investors creating value, but shorter-term players in the market would be taxed.”

Before the tax reform bill’s release, there was concern in the retirement industry that the annual 401(k) contribution limit for individuals could be lowered dramatically. The Wall Street Journal reported October 20 that lawmakers considered reducing the maximum amount of pretax dollars that individuals can contribute to their 401(k) plans to $2,400, from the current limit of $18,000.

“There will be NO change to your 401(k),” Trump tweeted October 23. “This has always been a great and popular middle class tax break that works, and it stays!”

The bill left 401(k) limits untouched, which is good for asset managers, said Scott Matheson, managing director at investment advisory firm CAPTRUST. “If you’re an asset manager, you wouldn’t expect to lose existing fees, but you’d have to think about what it means to your growth rate,” he said by phone. Hananel agreed, adding that it wouldn’t make sense for Congress to impose that limit given its struggles to finance social security.

“The social security system is under fiscal attack,” he said. “Where are people going to accumulate money to retire?”

Under the proposed bill, the excise tax paid by private foundations will be lowered to 1.4 percent, from 2 percent, and a provision allowing some foundations to pay as little as 1 percent would be removed. The excise tax would also apply to private colleges and universities with at least 500 students and endowment assets valued at least $100,000 per full-time student, an aspect of the legislation that the Association of American Universities would like to see changed.

“Imposing an excise tax on nonprofit private university endowments is a short-sighted move that will only harm students and their families,” Mary Sue Coleman, president of the group, said in a Nov. 2 statement. “Endowments support substantial student aid and student service programs, and provide funding for instruction, research, and for building and maintaining classrooms, labs, libraries, and other facilities.”

In the bill’s summary, Kevin Brady, chairman of the House Ways and Means Committee wrote that “endowments at many private colleges are large enough that parity requires that they be placed on equal footing with private foundations when it comes to paying a tax on net investment income.”

The committee estimates that lowering the corporate tax rate to 20 percent, from as high as 35 percent, would reduce tax revenues by $1.46 trillion between 2018 and 2027. Still, Hananel sees it as positive for the economy.

“It will make the U.S. more attractive to invest in, which is good for institutions,” he said.