Fixing the Double Deduction from Carried Interest

12 Pages Posted: 26 Apr 2011

See all articles by Calvin H. Johnson

Calvin H. Johnson

University of Texas at Austin - School of Law

Date Written: April 20, 2011

Abstract

Commonly and appropriately, a service partner is taxed on the value of a partnership interest transferred as compensation. When the value of the interest exceeds its tax book value (capital account), the partnership seems to be allowed a double deduction, akin to deduction of both the accrual and the payment of the expense. The partnership gets a deduction for the fair market value of the partnership interest that the service partner includes in income and the other non-service partners later allocate partnership income over to the service partner, which is functionally equivalent to a second deduction for the same item.

The Shelf Project proposal would limit the partnership’s deduction to the basis or capital account transferred to the service partner. The proposal also would tax sale of an income interest in the partnership as immediate ordinary income. The proposal would also apply to S corporation stock, where the problem is the same.

The proposal is equivalent to treating the partnership as if it had sold ordinary assets to pay the partnership interest. The discussion rejects the argument that the transfer of the partnership interest fits under section 721 for nonrecognition, and rejects an analogy between section 1032 (nonrecognition by a corporation in issuing stock) and section 721. It rejects the argument that the partnership should be treated as selling a fractional share of all its assets. A partnership can sometimes achieve a result better than the proposal by a real sale of assets, but the real sale would solve valuation difficulties and sometimes prevent the inappropriate accounting.

The proposal is made as a part of the Shelf Project, which is a collaboration among tax professionals to develop proposals to raise revenue in the ongoing revenue crisis by defending the tax base. It is intended to raise revenue without a VAT or a rate increase in ways that will improve the fairness, efficiency, and rationality of the tax system. The hard work needs to be done now to develop viable proposals. Shelf projects are intended to foreclose both 85 percent income tax rates and 60 percent federal sales taxes.

Shelf Project proposals follow the format of a congressional tax committee report in explaining current law, what is wrong with it, and how to fix it.

Suggested Citation

Johnson, Calvin Harsha, Fixing the Double Deduction from Carried Interest (April 20, 2011). The Shelf Project Tax Notes, p. 203, April 2011, Available at SSRN: https://ssrn.com/abstract=1816725 or http://dx.doi.org/10.2139/ssrn.1816725

Calvin Harsha Johnson (Contact Author)

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States
512-232-1306 (Phone)
512-232-2399 (Fax)

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