As Adam Lashinsky reports, a collective whine is rising from comfy VC offices as Congress contemplates the possibility of--horrors--making venture capitalists live by the same tax code as everyone else.
The issue? Thanks to the mountains of money private-equity firms have made in recent years, the industry has been attracting scrutiny, and someone noticed that private-equity firms, VC firms, and other "alternative" investment entities have for years enjoyed a sweetheart tax deal: The firms' performance-based fees (often 20% of profits) are taxed at long-term capital gains rates rather than ordinary income rates. The logic behind this treatment is flimsy at best, but it was probably made possible by the genius who labeled such fees a "carry" instead of "fees."
In any case, Congress is now considering making VC and PE firms pay regular old income taxes, a move that makes perfect sense to everyone except the VCs. The VCs, meanwhile, are trying several tactics to preserve their dream rates, including hiring lobbyists, making unctuous arguments that--unlike bloodsucking PE firms--they develop businesses and create jobs (so do working stiffs), and declaring that their performance-based fees are actually capital gains. Some VCs have even suggested that, if the tax-treatment is changed, the economy will suffer and they'll quit the business. (This last sentiment is particularly absurd: What are they going to do when they quit--go work in other, less-interesting, lower-paid businesses where people already pay income taxes?)
According to Adam, the VCs make two basic arguments about why their fees are actually capital gains:
- The fees take a long time to earn.
- The fees are performance-based.
Well, so what. Incentive comp is still comp. In the real tax world, meanwhile, it doesn't matter whether you provide your services for one day or ten years. A contractor who gets a lump-sum payment after a decade-long construction project pays income taxes, not capital gains. Employees who exercise and sell incentive stock options pay income taxes, no matter how long they've held the options. Etc.
The one argument not made about the tax treatment is the only one that would be valid: That VCs actually put their capital at risk. VCs don't put their capital at risk--they get paid to put other people's capital at risk. (A new law would presumably not affect the tax treatment of capital that partners have invested in their own funds--which would be capital gains).
VCs have enjoyed favorable tax rates for years, and no one can blame them for hoping the gravy train will continue. There's a difference between quietly hoping and making embarrassing, self-serving arguments, however--especially when VCs can lock in great tax rates forever just by investing in their own funds.