A US government proposal to increase the level of tax on carried-interest income has scared private equity and hedge funds

A plan by the US government to increase the tax rate on carried-interest income has alarmed private equity and hedge funds since it may hurt both small businesses and major institutional investors, according to a Reuters story.

The compensation of private equity and hedge fund managers, which is closely correlated with the profitability of the funds, would be most impacted by a prospective tax increase.

A carried interest would only become applicable for investments under the proposed rules after five years, two more years than under the current rule. However, the proposal also solves several other loopholes, according to Alex Farr, a tax partner at the law firm McDermott Will & Emery.

Many private equity and hedge fund financiers benefit from carried interest, a tax advantage that enables them to pay a reduced rate of capital gains tax on their income as opposed to higher income tax rates. 

The regulation change, which is anticipated to increase tax collection by an additional $14 billion, has been under consideration by senators for more than a decade.

The shift is part of a larger Democratic plan to raise taxes on corporations and the rich in order to fund increased expenditure on energy, electric vehicle tax credits, and investments in health care. Currently, carried interest only applies to investments after three years.