The carried interest rules are a set of tax rules that offer favorable tax treatment when a partnership interest in a private equity or hedge fund in exchange for future services to the partnership. In lieu of cash compensation, the services entitle the individual to receive a share of future partnership profits.
Instead of being taxed for compensation at ordinary income tax rates, recipients of future partnership profits are usually entitled to pay tax at the long-term capital gains tax rates, which are, of course, substantially lower than ordinary income tax rates.
Under the 2017 tax reform legislation, a three-year holding period requirement applies to certain recipients in order to gain long-term capital gains treatment. President Joe Biden is proposing to permanently eliminate these carried interest tax rules so that recipients would be required to pay ordinary income tax rates on amounts received.
We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about eliminating the current beneficial tax treatment under the carried interest rules.
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Below is a summary of the debate that ensued between the two professors.
Bloink: The carried interest rules are yet another tax loophole to allow wealthy private equity and hedge fund managers to avoid paying their fair share of income taxes. This is a change that should have been implemented years ago, and it’s about time we started focusing on the nitty-gritty ways wealthy taxpayers manage to avoid almost all tax liability.
Byrnes: It makes complete sense that carried interest should be treated as capital gains income — because these benefits are most similar to investment income or a return on goodwill. Biden’s already calling for a long-term capital gains tax rate hike that would cause rates to skyrocket to 39.6% — higher than the current top ordinary income tax rate. Focusing on the carried interest rules is really just a backstop, in case he’s unable to pass the capital gains tax hikes he has in mind.