An Analysis of the "Carried Interest" Controversy
Publication Date: August 2007
Author(s): Aviva Aron-Dine
Special Collection: John D. and Catherine T. MacArthur Foundation
Keywords: Economic projections; Corporate finance; Tax code; Income diversity
A carried interest is a right to receive a specified share (often 20 percent) of the profits ultimately earned by an investment fund without contributing a corresponding share of the fund’s financial capital. It is part of the standard compensation package for managers of private equity funds. Current law allows these managers to pay tax on all or most of their carried interest income at the 15 percent capital gains rate, instead of at the individual income tax rate that would otherwise apply, typically 35 percent for these high-income individuals. Rather than being taxed as managers receiving compensation for services rendered, recipients of a carried interest are taxed as though they were investors who had supplied 20 percent of the financial capital of the fund. In addition, a small group of private equity firms are beginning to take advantage of a provision of current law that makes it possible for them to avoid paying corporate income taxes, even after issuing public stock. Prior to the development of this new tax strategy, nearly all publicly-traded partnerships were subject to the corporate income tax. Both of these issues are attracting congressional scrutiny.