During last night’s debate, you heard both candidates mention “carried interest.” If you’re not a professional investor, chances are, you may not be familiar with this term. Here’s a brief explainer.


Let’s say you’ve made an investment, and that investment grows over the next three years. You sell it and make a profit—nice! That’s called a capital gain, and you have to pay taxes on it. The good news is, your capital gain is usually taxed at a lower rate than your income.

And then there are private equity and hedge funds. These groups of investments aren’t available to the general public, but they’re managed by general partners who obviously want the fund to be as profitable as possible. These partners are paid in fees from the fund, but they’re also paid in carried interest—a share of the fund’s profits. If the fund does well, they get a cut of the profit. And those profits are taxed as capital gains. The capital gains tax rate varies depending on income, but it hits a ceiling at 23.8%, whereas wage and salary income is taxed at 39.6% (plus 3.8% for investments).


In short, carried interest is compensation for the fund’s partners, but it’s considered a capital gain, not income, so it’s taxed at a lower rate. Here’s how Investopedia breaks it down:

The carried interest portion, which typically amounts to 20% of the net profits, is vested over a number of years and received as earned after that point...Carry is not automatic; it is only created when the fund generates profits that exceed a specified return level known as the hurdle rate. If the hurdle rate of return is not achieved, the general partner does not receive carry...

Both Clinton and Trump mention taxing this as ordinary income. The idea is that this “interest” is basically a salary for the fund manager and it should be taxed as such. Those in favor of taxing it this way point out that investment bankers pay ordinary rates for their own compensation, including wages, salaries, and bonuses. Fund partners should be taxed the same way, especially considering private equity funds manage a few trillion dollars a year.

Not everyone sees it that way, though. As the Tax Policy Center explains, opponents point out that managers aren’t investment bankers, they’re more like entrepreneurs:

But others believe that the general partners are more like entrepreneurs who start a new business and may, under current law, treat part of their return as capital— not as wage and salary income—for their contribution of “sweat equity.” Our tax system largely accommodates this conversion of labor income to capital because it cannot measure and time the contribution of the “sweat equity.”


Critics also argue that taxing it as income would take away the incentive for managers to make the funds profitable. Over at Forbes, writer Ryan Ellis argues that changing the way carried interest is taxed would encourage businesses to change their partnership arrangements accordingly to avoid the hike.

There are additional arguments for and against taxing it as ordinary income, of course, but these are the basics. The Tax Foundation has some interesting predictions (PDF) about what would happen if we tax carried interest as ordinary income. They predict that 2,200 jobs would be lost, for example, and they also predict that “taxing carried interest as ordinary income would raise $15 billion over the next decade.” Check out their report in full here (PDF) and for more info on carried interest, you can head to the Tax Policy Center’s page on the topic.


What is carried interest, and how should it be taxed? | Tax Policy Center

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