Carried interest has long been a contentious topic in the world of finance and taxation, often described as a lucrative incentive for private equity, venture capital, and hedge fund managers. At its core, carried interest represents a share of a fund’s profits allocated to general partners, rewarding them for their role in managing and growing investments. Unlike traditional income, it is taxed at the lower capital gains rate, sparking ongoing debates about fairness, tax policy, and economic incentives. As lawmakers in both the U.S. and the U.K. reconsider the tax treatment of carried interest, the issue remains a focal point in discussions about wealth, taxation, and financial industry regulation.
What is carried interest?
Carried interest is a share of profits given to general partners of private equity, venture capital, and hedge funds as incentive compensation. It is earned based on their role rather than an initial investment and aligns their earnings with the fund’s performance. Typically, carried interest is only paid if the fund meets a minimum return (hurdle rate) and is taxed as a long-term capital gain, which has a lower tax rate than ordinary income. Since it is distributed over time, it also allows for tax deferral similar to unrealised capital gains.
How is carried interest taxed in the U.S?
Carried interest on investments held for over three years is taxed as a long-term capital gain at a top rate of 20%, compared to 37% for ordinary income. Critics argue this benefits the wealthy by allowing them to defer and reduce taxes, while supporters compare it to “sweat equity” investments. The 2017 Tax Cuts and Jobs Act extended the required holding period from one to three years, with complex IRS rules introduced in 2021. Since private equity and venture capital funds typically hold investments for five to seven years, some lawmakers have proposed taxing carried interest annually as ordinary income. Carried interest is controversial because it is taxed as capital gains, which has a lower tax rate than ordinary income. This allows general partners to pay less in taxes despite often earning more than regular employees, creating a perceived tax inequality.
Closing the Loophole: What’s happening in the U.S?
President Donald Trump has renewed his push to eliminate the carried interest tax treatment, which allows private equity and hedge fund profits to be taxed at the lower capital gains rate instead of as ordinary income. Speaking to Republican lawmakers, Trump emphasised closing this “loophole” as part of his broader tax reform agenda. The carried interest tax benefit has long been a contentious issue, with previous reform efforts—including during Trump’s first term in 2017—failing due to congressional opposition. While many Republicans and some Democrats have historically resisted changes, the current political landscape may be shifting, with some Democrats openly supporting Trump’s stance.
The 2017 tax bill had already extended the required holding period for carried interest tax benefits from one to three years. Some policymakers suggest further extending this timeframe rather than eliminating the provision entirely. Meanwhile, private equity groups continue to argue that the existing tax treatment incentivises long-term investment and job creation. Trump’s proposal reflects a broader shift in Republican priorities, signalling a potential departure from traditional pro-business policies. As the debate unfolds, it remains uncertain whether this latest attempt to close the carried interest loophole will succeed where past efforts have failed.
The position in the UK
In the United Kingdom, the taxation of carried interest has undergone significant changes. As of April 2025, the capital gains tax rate on carried interest will increase from 28% to 32%. Further reforms are planned for April 2026, which will treat all carried interest as trading profits subject to income tax at rates up to 45%, plus Class 4 National Insurance contributions of up to 2%. This results in an effective tax rate of approximately 34.075% for additional rate taxpayers.
These reforms aim to align the taxation of carried interest more closely with other forms of income, addressing concerns about fairness in the tax system. However, there are concerns that such changes could impact the UK’s competitiveness in attracting and retaining investment talent, particularly in London, a major financial hub. The private equity industry has expressed apprehension that higher taxes may deter fund managers and investors, potentially leading to a relocation of financial activities to more tax-favorable jurisdictions.