Obama Proposes New Taxation of Private Equity Fund Managers’ Carried Interest

Steve D. Kesten

June 23, 2010

President Obama recently proposed to tax the income from so called “carried interest” as ordinary income rather than capital gains as it is under current law.

Currently, ordinary income is subject to marginal tax rates up to 35% (39.6% in 2011) while income from capital gains is taxed at a maximum rate of 15% (20% in 2011). Carried interest accrues to certain investment fund managers, including managers of private equity funds, hedge funds and venture capital partnerships. These managers often receive part of their compensation in the form of an interest in the partnership, which entitles them to a share of partnership profits. If the partnership earns a capital gain, the manager reports his share – the carried interest – as capital gain income. Obama’s proposal would tax this income as ordinary income on the grounds that the income represents compensation for services, not a return on investment.