Virginia No-Limit Campaign Laws = Tax Exemptions for Partners in Venture Capital Firms

by James C. Sherlock

Updated Dec 14 at 10:19 AM

I just spent some spare time browsing through the Virginia tax code. (I know, get a life.) Lots of interesting items in there. Some tax exemptions make sense for the best interests of the state. Some don’t.

This case benefits a very few people a lot.  It is harder to figure out what is in it for the state.

If you are a partner in a venture capital company, you get a large and controversial federal tax break for what is called carried interest. Great being you.

Since 2018 Virginia does not tax income, including investment services partnership interest income (that same carried interest income) attributable to an investment in a Virginia venture capital account.

A Virginia venture capital account is defined as an account with half of the money in Virginia companies, including those in target-rich Northern Virginia. Even better being you.

Is America a great country or what?

The federal government taxes “carried interest” — a share of a private equity or fund’s profits that serve as compensation for fund managers — at long-term capital gains rate instead of as ordinary income. In some quarters, this is considered a scandal.

From the Congressional Research Service:

Much of the concern over the tax treatment of carried interest has been about its fairness and economic efficiency, which may be of increased salience as investments in alternative investment vehicles have grown. As of the second quarter of 2019, private equity and hedge funds had roughly $14.3 trillion in assets under management—an increase of nearly 40% over the past four years.

Under the current characterization of carried interest, general partners’ performance fees are taxed less heavily than other forms of compensation, leading to distortions in employment, organizational form, and compensation decisions. It is also argued that the current treatment of carried interest violates the principles of both horizontal and vertical equity.

Carried interest is not automatic and is only issued if a fund or private equity firm performs at or above a designated level.

In a typical scenario, about 80% of carried interest eventually trickles down to the fund’s limited partners, those who initially invested capital. The general partner receives the other 20%, as well as compensation in the form of an annual management fee—a percentage of the fund’s assets.

Now see Virginia Code Title 58.1. Taxation § 58.1-322.02. Virginia taxable income;  subtractions:

27. a. Income, including investment services partnership interest income (otherwise known as investment partnership carried interest income), attributable to an investment in a Virginia venture capital account. To qualify for a subtraction under this subdivision, the investment shall be made on or after January 1, 2018, but before December 31, 2023.

b. As used in this subdivision 27:

“Qualified portfolio company” means a company that (i) has its principal place of business in the Commonwealth; (ii) has a primary purpose of production, sale, research, or development of a product or service other than the management or investment of capital; and (iii) provides equity in the company to the Virginia venture capital account in exchange for a capital investment….

“Virginia venture capital account” means an investment fund that has been certified by the Department as a Virginia venture capital account….

… the Department shall certify the investment fund as a Virginia venture capital account at such time as the investment fund actually invests at least 50 percent of the capital committed to its fund in qualified portfolio companies.

From Virginia Tax in implementation of the law:

For taxable years beginning on or after January 1, 2018 taxpayers may claim an individual and corporate income tax subtraction for income attributable to an investment in a Virginia venture capital account made on or after January 1, 2018, but before December 31, 2023. For the purposes of this subtraction, income includes, but is not limited to, investment services partnership interest income, otherwise known as investment partnership carried interest income.

OK, I’ll bite.  Three options that I can think of for why this tax code change was passed.

  1. It was meant to cause venture capital funds to invest in Virginia companies that they would not otherwise find financially attractive. Does anyone really think such investments would be made hoping for a 5.75% break on carried interest if they made a profit?
  2. It was meant to reward venture capital funds for investing in Virginia companies they would have invested in anyway.  That is at best a waste of money.
  3. It was meant to reward campaign donors who were already located here and already investing in both Virginia companies.

I wonder how much money is “subtracted” each year for this provision and by how many Virginians.  It would really be meaningful if we knew the amount of the average subtraction by those taking advantage of it.  I am going to guess it is a lot of money by very few Virginians –  the kinds of people who are big campaign contributors.

The process is corrupted by the lack of limits on campaign donations in Virginia, not by those who give them.

Joint Subcommittee on Tax Policy.  Item 1 (AA) of the 2021 Appropriation Act (House Bill 1800, Special Session I, Chapter 552):

“This amendment establishes a Joint Subcommittee on Tax Policy to evaluate and make recommendations on potential changes to Virginia’s tax policies, including changes to tax brackets, tax rates, credits, deductions, and exemptions, and any other changes it deems necessary.”

“The Joint Subcommittee will consider factors such as equity, certainty, convenience of payment, economy in collection, simplicity, neutrality, economic efficiency and any other factors it deems relevant to the Commonwealth’s tax policies.”

The 12 members are appointed by Chair of House Appropriations (6) and Chair, Senate Committee on Finance and Appropriations (6), so the House members will be new this term.

We can watch and see what they do with the “subtraction” for carried interest.

I hope, just this once, they surprise us.