Hedge funds face more trouble on Capitol Hill

The hedge fund industry, which is as popular on Capitol Hill as Iranian President Mahmoud Ahmadinejad, may have more trouble coming its way from the U.S. Congress.

The Wall Street Journal is reporting that the Senate Finance Committee may change the tax rules to prevent offshore hedge funds from using derivatives to avoid withholding taxes on U.S. stock dividends, a practice which costs the U.S. treasury $1 billion in revenue.

Wall Street firms such as Citigroup Inc. (NYSE: C) and Lehman Brothers Holdings Inc. (NYSE: LEH) are "bracing for questions," the paper said, Maybe that's a polite way to say that the companies are going to get tons and tons of rude questions from irate Democratic senators who are convinced that they are cheating the government.

The funds also are facing scrutiny over how managers can pay 15 percent capital gains tax on their performance fees instead of the 35% ordinary top income tax rate, a tax break that Talking Points Memo estimates costs taxpayers between $4 billion and $6 billion.

Hedge funds , though, are fighting back. As Politico.com notes, they spent $1.3 million lobbying Congress last year, up 46% from 2002 while managers at the top 30 funds increased their political donations by about 17% to $14.7 million between 2004 and 2006.

As the presidential election heats up, the industry will become even more generous.