WASHINGTON (CNN) - Hedge fund managers stand to pay much higher taxes on their earnings under proposals in President Barack Obama's first budget, which was unveiled Thursday.
The administration proposes reclassifying managers' partnership income as ordinary income, rather than capital gains - effectively more than doubling the rate of tax on the money from 15 percent to 35 percent, or even more.
For many years, most hedge funds have operated on a "two and 20" basis, meaning that they charged 2 percent of the amount they were managing and also received 20 percent of whatever profits the hedge fund made in a year.
They currently pay the long-term capital gains tax rate - 15 percent - on much of the "20" - the 20 percent share of their fund's profits.
This 20 percent cut of profits, called "carried interest," will all be taxed as ordinary income under the Obama plan beginning with income earned in 2011. The lower tax rate for hedge fund managers has been controversial because most of the capital in a hedge fund belongs not to the managers, but rather to its investors. Proponents of the change say that the 20 percent cut of profits is therefore just a fee paid by the real investors, and should not be taxed as a capital gain for the partners managing the hedge fund.
There have been earlier proposals along similar lines, but hedge fund managers have been able to beat them back in the past. The current unpopularity of hedge fund managers, however, may make it harder for them to do so this time.