For a decade, Congress has been debating how to tax managers of private equity firms. The argument is pretty familiar to tax wonks: Should these partners treat this compensation (commonly called carried interest) as capital gains, as they do today? Or should they be taxed at the higher ordinary income rate as President Obama and others have urged?
But what if the predicate of the debate is wrong? What if the returns to private equity firms themselves, as well as their managers, are already ordinary income under current law? What if the IRS has been getting it wrong all these years to the great benefit of private equity funds and similar investment firms?