Tax Terms: Carried Interest and the Buffett Rule

Contributed by: Matt Trujillo, CFP® Matt Trujillo

If you followed the 2016 campaign coverage as closely as I did, than you probably heard some tax-related terms repeated time and time again. Two terms in particular were “carried interest” and the “Buffet Rule.” For those that aren’t terribly familiar with these terms I will attempt to give a brief description of each.

What is "Carried Interest?”

Carried interest refers generally to the compensation structure that applies to managers of private investment funds, including private-equity funds and hedge funds. As a result of the carried interest rule, fund managers' compensation is taxed at lower long-term capital gain tax rates rather than at ordinary income tax rates. Both Clinton and Trump released plans calling for carried interest to be taxed as ordinary income.

What is the "Buffett Rule?”

In a 2011 opinion piece, Warren Buffett, chairman and CEO of Berkshire Hathaway, argued that he and his "mega-rich friends" weren't paying their fair share of taxes, noting that the rate at which he paid taxes (total tax as a percentage of taxable income) was lower than the other 20 people in his office (Warren E. Buffett, "Stop Coddling the Super-Rich," New York Times, August 14, 2011).

As Buffett pointed out, this is partially attributable to the fact that the ultra-wealthy typically receive a high proportion of their income from long-term capital gains and qualified dividends, which are generally taxed at lower rates than those that typically apply to wages and other ordinary income.

The "Buffett Rule" has since come to stand for the tenet that people making more than $1 million annually should not pay a smaller share of their income in taxes than middle-class families pay. As a result, some have proposed that those making over $1 million in annual income should have a flat minimum tax of 30%.

What is the right thing to do? That is not for this humble author to decide. But at least now, some of you can be better informed about what these terms mean the next time you hear them on the news!

The tax environment is evolving rapidly. Be sure to talk to a qualified professional before implementing any changes to your tax and investment strategy.

Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc.® Matt currently assists Center planners and clients, and is a contributor to Money Centered.

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