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Taxation of Hedge Fund and Private Equity Managers, July 8, 2008 1 (July 8, 2008)

handle is hein.tera/crstax0272 and id is 1 raw text is: Order Code RS22689 Updated July 8, 2008 A CRS Report for Congress Taxation of Hedge Fund and Private Equity Managers Mark Jickling Specialist in Public Finance Government and Finance Division Donald J. Marples Specialist in Public Finance Government and Finance Division Summary Hedge funds and private equity funds are investment pools generally available only to institutions and wealthy individuals. Private equity funds acquire ownership stakes in other companies and seek to profit by improving operating results or through financial restructuring. Hedge funds follow many strategies, investing in any market where managers see profit opportunities. The two kinds of funds are generally structured as partnerships: the fund managers act as general partners, while the outside investors are limited partners. General partners are compensated in two ways. First, to the extent that they invest their own capital in the funds, they share in the appreciation of fund assets. Second, they charge the limited partners two kinds of annual fees: a percentage of total fund assets, and a percentage of the fund's earnings. The latter performance fee is called carried interest and is treated as capital gains under current tax rules. Several bills relating to the hedge fund issue have been introduced to date in the S0th Congress. S. 1624 would require private equity firms organized as publicly traded partnerships to pay corporate income tax. H.R. 2834, H.R. 3996, and H.R. 6275 would make carried interest taxable as ordinary income. H.R. 4351 and H.R. 6049 would include in gross income the portion of carried interest currently deferred offshore in foreign-chartered funds. In addition to summarizing the legislation, this report provides background on hedge funds and private equity and summarizes the tax issues. It will be updated as legislative developments warrant. Background Private Equity. Private equity firms buy and sell other businesses. The industry can be roughly divided into two parts: venture capital and buyout funds. Venture capitalists invest in small, startup firms, providing financing and management expertise. Their payoff usually comes when the firms are sold, either by selling shares into the Congressional Research Service < The Library of Congress Prepared for Members and Committees of Congress

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