Taxation of Carried Interests is Reignited by Recent Congressional Bill

IM Report Taxation of Carried Interests is Reignited by Recent Congressional Bill Debbie A. Klis · February 17, 2021

Representatives Bill Pascrell (D-NJ), Andy Levin (D-MI) and Katie Porter (D-CA) released H.R. 1068[1] on February 16, 2021, known as the “Carried Interest Fairness Act” (the “Act”).  The Carried Interest Fairness Act would tax carried interest compensation at ordinary income tax rates and treating it as wage income subject to employment taxes.  Capital gains taxation would still apply to general partners and managers who invest capital in their funds.  All other income received that is disproportionate to the general partner’s or manager’s investment would be taxed at ordinary rates.

According to a 2018 analysis of similar legislation by the non-partisan Congressional Budget Office, the Act, if adopted, would generate more than $14 billion in revenue over ten years; some experts believe it would generate more than ten times as much to the Treasury.[2]

By way of background, the carried interest is the general partner or investment adviser’s share of partnership income that is compensation for the expertise provided including fundraising, asset management and investment decisions rather than a return on capital investment.  Because of the compensation component, law makers have long struggled with the taxation mismatched that compensation is not taxed as ordinary income rates as traditional employment compensation is so taxed.

The most recent legislation affecting the taxation of the carried interest occurred as part of the Tax Cuts and Job Act of 2017 (“TCJA”).  The TCJA required that general partners and investment managers hold their applicable investments for three years instead of one to receive long-term capital gains treatment on their carried interest.   The Act would likely abolish the protections afforded to carried interest taxation in the TCJA.

Financial markets experts predict that the Act has an insignificant chance of passing as significant sums of money will be spent to fight it.

[1] The legislation is cosponsored by Reps. Don Beyer (D-VA-08), Tom Suozzi (D-NY-03), Earl Blumenauer (D-OR-03), and Judy Chu (D-CA-27).
[2] https://pascrell.house.gov/news/documentsingle.aspx?DocumentID=4610