How carry is taxed impacts the value to those who share in it. In the U.S., carried interest is taxed as a long-term capital gain (15 percent) rather than as ordinary income (up to 35 percent tax). Partnerships do not pay income taxes, so all taxes are paid by the firm’s carry recipients directly.
However, multiple factors, including a huge U.S. federal deficit, prompted Congress to look for ways to bring in more tax revenue. The House Ways and Means Committee introduced “The American Jobs and Tax Loopholes Act of 2010” which called for taxing 75 percent of carried interest as ordinary income.
The logic went like this – investment fund managers receive carry for services provided, therefore, it should be taxed as ordinary income.
This proposed tax increase on carry was met with a lot of resistance from Wall Street, and equal support from proponents. Fortunately for private equity professionals, this bill never became law and carry continues to be taxed as a capital gain.
Do we think this is a dead issue? No. With the current administration, we’ll likely see another flavor of this type of regulation proposed.
If you are interested in learning more about carried interest, check out the The Private Equity Professional’s Guide to Carried Interest
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