02/12/2025
What is the carried interest tax loophole?
In this post I’ll break it down, but before I do, here’s a quick history lesson:
Back in the thirteenth century, long-distance trade had the potential to generate enormous profits. If merchants could fill a ship with goods, they stood to make a lot of money.
The problem was few merchants had the capital to acquire the goods and hire a ship.
And this is where carried interest comes in.
Merchants would bring on investors who would fund the trading expedition. And the merchants would get a cut of the profits once the trip was complete.
The merchants had an “interest” in the profits from the trip and they were literally “carrying” goods across the sea.
In today’s world, a carried interest works in a similar fashion in that a fund manager (general partner = GP) will raise investor capital, make investments, and share in the profits.
The standard fee structure today is 2/20 (two and twenty). The “2” represents 2% management fees charged by the GP to investors. The “20” represents the 20% profit split the GP gets from the investments.
The carried interest loophole is all about how the “20” is taxed.
The issue is the 20% profit split often generates incredible profits for the GP.
And those profits are taxed at long-term capital gain rates rather than ordinary rates.
Proponents of carried interest claim that the 20 should be taxed at long term rates because the profits are resulting from strong investment decisions.
Opponents claim that this is primarily how the GP earns their income and should be taxed at ordinary rates as a result.
Even Warren Buffett was quoted saying: “if you believe in taxing people who earn income on their occupation, I think you should tax people on carried interest.”
But there’s one last thing to know…
Nixing the carried interest loophole will only raise ~$12-15B over ten years.
It’s almost not worth the effort.
What do you think?
