Untangling The Carried Interest Controversy

Abstract

Carried interest is a form of deferred compensation payable to managers of hedge funds organized as investment partnerships. There are two tax components of this compensation that are favorable to the manager. First, income taxes are due only when amounts are received rather than when this interest is granted, and second, this income is eligible for the lower tax rates of capital gains and dividends. Special tax treatment has been criticized by some as being an unfair benefit for income that is essentially compensation for services, while proponents of continuing this special treatment point out policy reasons for continuing it, emphasizing characteristics of carried interest that warrant treatment such special treatment. Legislative changes have been proposed but not enacted into law, and there are different alternatives that warrant consideration for the future.