For the 172,000 businesses in New Jersey organized as partnerships, a reform to the current tax law suggested by President Barack Obama could nearly double the amount of taxes paid when the partnership is sold, according to a report issued today.
The Common Sense Institute of New Jersey issued its findings on economic impact to the state if an enterprise value tax is enacted. The EVT is one of several reforms put forth by the president in his Plan of Economic Growth and Deficit Reduction, and could be suggested again this spring in congressional tax reform debates.
According to Scott Moody, author of the report and tax policy economist with the association, a change in the way partnerships are taxed when sold could increase the amount paid annually by information, real estate and financial firms doing business in New Jersey from $342 million to $685 million.
The plan would change the tax paid on the sale of a partnership share from the current capital gains tax to regular income tax, if the share was given as a form of compensation for operating a partnership, or carried interest. The tax could increase from the 15 percent capital gains tax up to 35 percent, according to Moody. Other triggers for the higher tax rate would include interest income, investment real estate or securities.
“The problem with the EVT is it is written so broadly, it could potentially ensnare any partnership that at any point and time paid so much as $1 in carried interest — even in previous transactions,” Moody said. “You can’t plan in an environment like that, so it has severe economic consequences.”
Moody attributes the proposed tax change to attitudes about Wall Street, as well as the view of partnership shares as a form of income rather than a risk.
“What they’re forgetting is (the managing) partner’s interest, just like the investor’s interest, is based on a risk. If the partnership fails, that share is worth nothing,” Moody said. “Carried interest is dependent upon the financial picture of the organization that you’re managing.”
According to the report, there will be nearly 4 million businesses organized as partnerships in the United States by the end of the year, with $18.8 trillion in assets. Of those assets, $9.7 trillion worth of assets are associated with “sweat equity” of a partnership, therefore exposing them to the income tax rather than the capital gains tax.