The carried interest loophole allows investment managers, particularly those in private equity and hedge funds, to pay a lower tax rate on a portion of their earnings. This feature of the U.S. tax code is controversial for enabling certain high-income individuals to be taxed at the capital gains rate instead of the higher ordinary income tax rate.
Carried interest refers to the share of profits that general partners (managers) of investment funds receive as compensation, typically about 20% of the fund's profits. This income is currently taxed at the long-term capital gains rate of up to 20%, rather than the ordinary income tax rate, which can be as high as 37%. This tax treatment is based on the premise that carried interest represents a return on investment rather than payment for services rendered.
Closing the carried interest loophole has been a topic of debate among policymakers. The Congressional Budget Office estimated that taxing carried interest as ordinary income could generate approximately $12 billion over ten years. While this amount is relatively modest in the context of the federal budget, proponents argue that closing the loophole would enhance tax fairness by ensuring that high-income investment managers pay tax rates comparable to those of other workers.
Allowing the carried interest loophole to persist benefits the ultra-wealthy while regular working Americans pay higher effective tax rates. Closing this loophole is a step toward a fairer tax system.