By Yuting Chen, CPA, Tax Manager
On February 6, 2025, President Donald Trump had discussions with Congressional Republican leadership about proposals for eliminating the favorable capital gains tax treatment on carried interest for ordinary income tax treatment, such as compensation. The proposal aligns with bipartisan efforts, as Democratic senators had introduced the Carried Interest Fairness Act of 2024, aiming for similar changes. The proposed changes have significant implications for investment fund managers, the financial industry, and the economy as a whole.
Carried interest tax treatment controversy – loophole or legitimate?
Tax loophole perspective
Some critics perspective of current tax treatment is that carried interest is basically compensation for services, not a return on investment. Thus, it should be taxed as a salary instead of capital gain. The current preferential tax treatment is seen as a loophole that benefits fund managers which creates inequality in taxation between general partners who receive carried interest and regular employees who receive salaries.
Legitimate tax treatment perspective
Meanwhile, the defenders of current tax treatment argue that general partners receive management fees for their routine services, which are taxed as ordinary income and carried interest is not compensation for services. The defenders also argue that carried interest reflects long-term risk and performance-based incentives. Changes to this treatment could restrict access to capital which results drive capital away from American funds, hurting economic growth and innovation.
What’s next?
The current proposed bill on tax treatment of carried interest is still at the beginning stage of the legislative process and it is uncertain whether 2025 will be the year of change or once again remains in committee.
Background – What is Carried Interest?
Carried interest is a share of partnership profits from an investment that general partners, usually the fund managers of private equity, venture capital, or hedge funds, receive as part of their compensation – usually about 20% of the gain. Through a special provision of the law, carried interest is taxed as preferential capital gain versus ordinary income. This means carried interest that is associated with gains from the sale of an asset held for more than three years will be taxed at the long-term capital gains rate currently at 23.8% (20% on net capital gains plus 3.8% net investment income tax), instead of the highest tax rate on ordinary income at 40.8% (37% ordinary income rate, plus 3.8% net investment income tax). Additionally, because carried interest is not classified as earned income, it is not subject to the self-employment tax.
Our tax and Financial Services industry teams are closely monitoring these and other tax regulation changes. We will continue to provide you with updates to help you maximize tax planning and saving opportunities.
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About the Author
Yuting Chen, CPA, Tax Manager
Yuting has over five years of experience in public accounting providing tax services to public and private entities and their owners. She specializes in multi-state taxation, C-corporate taxation, and private investment funds taxation.
More Insights from Yuting ChenThe information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.
