Proposal to Tax Carried Interests as Ordinary Income

2010budgetThe Obama Administration has labeled their 2010 budget as A New Era of Responsibility. Part of that responsibility appears to be taxing carried interest as ordinary income.

On page 122 of the budget there is a single line item: “Tax carried interest as ordinary income,” with projections of $2,742 million in 2011, $4,347 million in 2012 and an overall $23,894 million for the ten year period.

There is no corresponding text about how the tax would be implemented, so it is premature to be thinking about how this might affect the business plan of a private investment fund.

Unlike a fixed fee, a carried interest aligns the interests of sponsors and investors with the success of the fund. Under current law, the grant of a carried interest generally is not taxable. Instead, the sponsor recognizes income and gain when allocations of partnership income and gain are made. For a partnership that generates long-term capital gains, the carried interest share of the gains would be taxed at the long-term capital gains rates (currently 15%) instead of ordinary income.

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