It’s true – Trump can’t always get what he wants. However, if you look closely, you just might find, he gets what he needs. While carried interest did survive, technically speaking, a deeper dive into the particulars reveals a significant change that may prove to be unfavorable to the hedge fund industry.
Three Year Holding Period
Under the old tax code, gains from the sale of a capital asset held for longer than one year were generally qualified to receive long-term capital gains treatment. The new provision, applicable to taxable years beginning after December 31, 2017, provides that gains arising from the sale of capital assets held for three years or less, will be treated as short-term capital gains and, as a result, be taxed at the higher ordinary income rates.
Interestingly, this change will have substantially less impact on the private equity industry as its investments routinely exceed the three-year boundary; however, the nature of the hedge fund industry makes it much more vulnerable to the consequences of this redefinition of a short-term holding. While long-term capital losses can be used as an offset, this is an undesirable scenario for any hedge fund.
Trump’s Catch-22
Insofar as hedge funds are concerned, the benefit provided by carried interest has been dealt a serious blow. The private equity industry, much less a target of negative press on the subject of carried interest, is also much less affected by the change. Undoubtedly, this is how the legislators wanted things to evolve—they know that private equity is much more dependent on carried interest for its profits than are hedge funds.
The problem for the Trump administration is that this is all very difficult to explain to the average person on the street. The changes to the tax law largely have the effect of stripping away the benefits of carried interest for the hedge fund industry. How far into the weeds the Administration and Republicans will go to prove the point is questionable. So far, we haven’t heard a word on the subject. This is Trump’s Catch-22. He has achieved his end, but it is difficult to explain the means.
Unintended Consequences
Every piece of legislation creates unintended consequences. What these consequences will be for the Tax Cuts and Jobs Act has yet to unfold. Will the bill extend the bull run, give rise to inflation, create a wave of corporate stock buybacks, or some other economic catastrophe? Only time will tell. The clock starts ticking at midnight, December 31, 2017.
Final Thoughts
Thus far, media focus on the matter of carried interest has been minimal. Should the media choose to tout the fact that Trump failed to keep his promise to close the carried interest loophole, he may be forced into the weeds.
This may be something the media should avoid as President Trump can make a very solid case that the Tax Cuts and Jobs Act stripped many carried interest advantages from the hedge fund industry. The last thing the media needs is yet another “fake news” charge from President Trump, who failed to get what he wanted, but did get what he needed.
