First of all, it is just a proposal. Schumer is promising a vote on the bill next week so we should have more clarity in a week’s time.
Second, the media is framing this as a complete close of the “loophole,” but my read is that this is only an adjustment to the rule. Currently, fund managers can take advantage of carried interest (i.e. pay lower tax rate on certain proceeds) after three years in a specific investment. However, the current proposal only alters this hold period, extending it from three to five years. Said differently, as long as fund managers hold investments for five years, then they can still benefit from the advantaged tax treatment.
Third, I don’t think this is even directly relevant to the search community since carried interest is typically a fund-level construct. I will couch the forthcoming info with the obligatory “I’m not an accountant disclaimer” but let’s evaluate both components of searcher exit proceeds: 1) co-invest proceeds and 2) option package proceeds. 1) For the first category, any co-invest gains (i.e. proceeds minus basis) you put into the deal will be taxed at long-term capital gains (roughly 20% depending on what state you live in). Note: this assumes you hold for longer than one year, otherwise it will be taxed at the ordinary income rate, which is roughly 35% depending on your state and income level. Another note: there has been chatter recently about raising long-term capital gains rates, but that seems to have subsided. 2) The second component of exit proceeds come in the form of options, and this is really the area in question. For context, the options vest over time and with performance hurdles, and this is how searchers end up getting “larger percent ownership” in their deals by the time of exit. In the private equity operator world, the Management team’s options are generally structured as RSUs (restricted stock units) with a basis of zero, so you pay ordinary income tax on the entire amount of the option proceeds. My speculation is that searcher “options” are typically structured in a similar way to how it’s done for PE-backed PortCo. management teams. In these cases, searchers will also pay the ordinary income tax rate so “closing the loophole” would be irrelevant since options proceeds would not be treated as carried interest. However, some searchers may structure their acquisition entities, operating agreements, comp packages, etc. similar to how a PE fund does it (i.e. carried interest). This would allow the “options” component of searcher exit proceeds to be taxed at long-term capital gains, resulting in a significantly lower tax bill after holding for three years.
In conclusion, I don’t think any searchers should be reconsidering their decisions solely based on these emerging headlines. It would be helpful to hear from those with acquisitions under their belt so they can share how their options were structured, but if option packages are generally aligned with PE-backed portco structures, then the entire ‘closing the carried interest tax loophole’ proposal is irrelevant to searchers.