Private Equity – Carried Interest
Carried interest is the profit earned on private equity investments by a deal-maker in a private equity house. Often known as “carry”, it allows private equity professionals to receive up to 20% of the profit from a company they sell. The “carry” can be a significant portion of a private equity professional’s total compensation.
Private equity firms are typically structured as investment partnerships where the general partners manage the firm’s fund on behalf of the limited partners (the investors). The private equity firm then uses the fund to purchase an equity position in a number of companies. When these equity investments are sold, the investors typically receive 80% of the profits and the managers collect the remaining 20% (known as the carried interest).
Current Treatment – Carried interest profit is eligible for capital gains taper relief, which is why it is currently taxed as a capital gain at 15% for both investors and managers. Investment partnerships have long maintained this lower rate.
Debate and Future Outcome – In recent years, lawmakers have been pushing to tax carried interest as ordinary income, which would set a much higher rate than 15%. Supporters of higher taxing of carried interest, such as the Coalition for Tax Justice, have argued the issue is tax fairness. A bill proposing a change would require fund managers to treat carried interest as ordinary income. The bill would continue to tax carried interest at capital gain tax rates to the extent that carried interest reflects a reasonable return on invested capital. President Obama’s 2010 released budget proposes to raise taxes on carried interest to more than 39%, effective 2011.