(Bloomberg) — Some high-earning partners in hedge funds, private-equity firms and other businesses organized as so-called pass-throughs would pay a 3.8 percent health care income tax under President Barack Obama's 2017 budget request.
The proposal would extend a "net investment income tax" for Medicare that's been in place since 2013 to taxpayers who have successfully characterized their income in ways the tax doesn't reach, according to Obama administration officials. Combined with another provision, which is designed to require more business owners to pay self-employment taxes, the change is projected to raise $271.7 billion over the next decade.
See also: The Medicare surtax: Is it avoidable?
The measures are part of a package of revenue proposals that collectively would raise $2.6 trillion from 2017 through 2026, according to the president's budget request, which was released Tuesday. The revenue it seeks is 67 percent higher than Obama's 2016 proposal, driven by international tax-reform proposals, changes in the way high-income individuals are taxed and a previously announced fee on oil of $10.25 per barrel.
The spending plan is expected to face opposition in Congress, where budget committees in the House and Senate have signaled their disregard. They don't plan to ask Obama's chief budget architect to make his customary appearance to defend the proposals. But proposals that die in one Congress sometimes resurface later.
Closing gap
The Patient Protection and Affordable Care Act of 2010 (PPACA), which is also known as Obamacare, sought to shore up funding for Medicare by creating a 3.8 percent tax on net investment income for people who make more than $200,000 a year. Now, the administration proposes to close what budget documents call "a gap" in legal definitions that determine who has to pay that levy.
In essence, Obama's budget would extend the 3.8 percent investment tax's provisions to income that individuals receive for performing services — such as managing investments — at partnerships, LLCs and S corporations. The administration would reach those taxpayers by applying the investment tax to "gross income and gain from any trades or businesses of an individual that is not otherwise subject to employment taxes."
Partnership technique
At the same time, the budget proposes to make individual owners of "professional service businesses" subject to self-employment taxes in the same way, regardless of how their business is structured. Under current law, certain structures allow for avoiding self-employment levies.
The measures would counter an aggressive technique that lets investment-fund managers typically avoid most of the self-employment tax by using a complex structure, according to David Miller, a tax lawyer focused on financial transactions at Cadwalader, Wickersham & Taft LLP.
Miller described a technique in which an entity that manages an investment fund is set up as a limited partnership, in which the general partner overseeing the fund owns a tiny stake, typically 0.1 percent. Generally, limited partners, who aren't currently subject to the self-employment tax, hold the remaining 99.9 percent interest — allowing the individual owners of the fund manager to skirt the tax.
The proposals reflect that a growing portion of America's business income is generated through structures other than the traditional C corporations — the familiar form of a publicly traded company, like General Electric Co., which pays corporate income tax.
