Treasury chief says IRS to ban hedge fund tax dodge

Treasury Secretary Steven Mnuchin testifies before the Senate Finance Committee on Capitol Hill in Washington, Wednesday, Feb. 14, 2018, on President Donald Trump's fiscal year 2019 budget proposal. (AP Photo/Susan Walsh) less Treasury Secretary Steven Mnuchin testifies before the Senate Finance Committee on Capitol Hill in Washington, Wednesday, Feb. 14, 2018, on President Donald Trump's fiscal year 2019 budget proposal. (AP ... more Photo: Susan Walsh, STF Photo: Susan Walsh, STF Image 1 of / 1 Caption Close Treasury chief says IRS to ban hedge fund tax dodge 1 / 1 Back to Gallery

Treasury Secretary Steven Mnuchin said the Internal Revenue Service plans on closing a loophole that hedge-fund managers had been trying to exploit to avoid paying higher taxes on carried-interest profits.

Mnuchin told the Senate Finance Committee Wednesday that a Bloomberg News story this week, which detailed how hedge funds created scores of shell companies to work around the new carried-profit rules, prompted him to instruct administration officials to issue guidance on the subject within two weeks.

"I've already met with the IRS and our Office of Tax Policy this morning as a result of that article," Mnuchin told the committee. "Taxpayers will not be able to get that loophole."

The new guidance would effectively kill hedge fund managers' plans to create numerous shell companies in Delaware - corporate America's favorite tax jurisdiction - to get around the tax law's requirement that assets must be held for three years instead of one year to qualify for a lower tax rate.

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 percent - which includes a 3.8 percent 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 percent.

Big names appeared to be embracing the maneuver, which requires setting up limited liability companies for managers entitled to share carried-interest payouts.

President Donald Trump turned carried interest into a rallying cry during his populist presidential campaign, declaring that "hedge fund guys are getting away with murder." Critics from billionaire Warren Buffett on down essentially agree, saying carried interest is a fee-for-service and should be taxed at the individual rate. But money managers have successfully argued for years that carried interest is a capital gain.

Under pressure from industry lobbyists and exploiting a split among White House advisers, Congress in December failed to fulfill Trump's promise to end the tax windfall enjoyed by money managers. And lawmakers seemed to stumble in trying to narrow their tax advantage, writing the new carried-interest rule in a way that provided firms an easy escape.

Mnuchin's comments were in response to questions from Sen. Ron Wyden of Oregon, the top Democrat on the committee, who called the longer holding period for carried interest a "farce" given the hedge fund workarounds.

But the Treasury secretary pushed back on Wyden's comment that the legislation needed a fix, insisting that the IRS had the authority to resolve the issue through guidance.