Carried Interest Fairness Act of 2025
- Sponsor
- Rep. Perez, Marie Gluesenkamp [D-WA-3]
- Committees
- Ways and Means Committee (primary)
- Last action
- Feb 6, 2025
Bottom line
The bill aims to significantly increase the tax burden on investment managers' carried interest income by taxing it at ordinary rates and subjecting it to self-employment taxes, while also closing potential loopholes.
What it actually does
This bill fundamentally alters the tax treatment of 'carried interest'—the share of profits paid to investment managers—by recharacterizing it as ordinary income rather than capital gains. It also subjects this income to self-employment taxes and introduces broad anti-avoidance rules for various investment structures, including publicly traded partnerships and special purpose acquisition companies. Additionally, it changes the default election for partnership interests received for services under Section 83(b) of the Internal Revenue Code.
Proponents argue
Proponents argue that carried interest is compensation for services rendered, not a return on capital, and should therefore be taxed at ordinary income rates, similar to other forms of earned income. They contend that the current tax treatment is an unfair loophole that disproportionately benefits wealthy financial professionals and that this bill promotes tax fairness and generates much-needed federal revenue.
Opponents contend
Opponents contend that carried interest is a return on risk capital—the 'sweat equity' and expertise managers invest—and should retain capital gains treatment to incentivize long-term investment, capital formation, and economic growth. They argue that this bill would discourage investment in private equity, venture capital, and other funds, potentially harming job creation and innovation, and would add significant complexity to the tax code.
The bill is highly technical and requires significant time to understand its full implications, especially for those unfamiliar with partnership tax law and complex financial instruments.
Sec. 2(a) amending IRC Sec. 83(c)
Default Section 83(b) Election for Partnership Interests
This provision changes the default tax treatment for partnership interests received for services. Currently, taxpayers must actively elect to include the fair market value of the interest in gross income at the time of transfer (a Section 83(b) election) to start the capital gains holding period early. This bill makes that election the default, meaning recipients are treated as having made the election unless they actively opt out. It also specifies how to value such an interest for tax purposes.
Supporters argue
Supporters argue this change simplifies the process for common scenarios where an 83(b) election is desired, reducing administrative burden for many taxpayers and clarifying valuation rules.
Critics contend
Critics might contend that this could lead to unintended tax consequences for those unaware of the default change, forcing earlier income recognition in some cases without an active opt-out, and potentially creating liquidity issues.
Tradeoffs
The provision balances administrative simplification for common scenarios with the potential for inadvertent tax liability for uninformed taxpayers who do not actively opt out.
Sec. 3(a) adding IRC Sec. 710(a)
Recharacterization of Carried Interest as Ordinary Income
This is the core 'carried interest' change. It mandates that net capital gain from an 'investment services partnership interest' (i.e., carried interest) be treated as ordinary income. Net capital losses are also recharacterized as ordinary losses, but only up to the amount of previously recharacterized gains. This effectively taxes carried interest at ordinary income rates, which are typically higher than preferential capital gains rates.
Sec. 3(a) adding IRC Sec. 710(b)
Ordinary Income Treatment for Dispositions of Carried Interest
This section mandates that any gain on the sale or exchange of an investment services partnership interest be treated as ordinary income and recognized immediately, overriding other tax provisions. Losses are treated as ordinary losses up to previously recharacterized gains. Special rules apply for gifts, transfers at death, and certain exchanges or distributions of partnership property, generally preserving the ordinary income treatment or triggering gain recognition to prevent avoidance.
Sec. 3(a) adding IRC Sec. 710(c)
Defining 'Carried Interest' and 'Investment Partnership'
This section defines the key terms that determine the scope of the new rules. An 'investment services partnership interest' is an interest in an 'investment partnership' acquired in connection with providing investment management services (such as advising, managing, or arranging financing for specified assets). An 'investment partnership' is defined as one where substantially all assets are 'specified assets' (e.g., securities, real estate, commodities, cash) and less than 75% of the capital is from 'qualified capital interests' (i.e., actual capital contributions). It includes look-through rules for tiered entities and anti-abuse provisions to prevent circumvention.
Sec. 3(a) adding IRC Sec. 710(d)
Exclusion for Actual Capital Contributions (Qualified Capital Interests)
This section provides an exception for actual capital contributions made by investment managers. If an investment manager contributes their own capital to the partnership (a 'qualified capital interest'), the income attributable to that capital is still taxed at capital gains rates, provided allocations are made in the same manner as to other non-service providing partners. It includes detailed rules for determining and adjusting qualified capital interests, as well as anti-abuse provisions for loans used to acquire such interests.
Sec. 3(a) adding IRC Sec. 710(e)
Anti-Avoidance for Other Investment Management Income
This is a broad anti-abuse rule targeting non-partnership structures. If a person performs investment management services for an 'investment entity' (defined similarly to an investment partnership) or a 'special purpose acquisition company' (SPAC), and holds a 'disqualified interest' (e.g., equity, convertible debt, options, derivatives) whose value is substantially related to the entity's asset performance, then any income or gain from that disqualified interest is treated as ordinary income. Exceptions are provided for certain taxable corporations and S corporations.
Sec. 3(c) amending IRC Sec. 7704(d)
Carried Interest Income Disqualifies Publicly Traded Partnerships
This provision amends IRC Section 7704, which generally taxes 'publicly traded partnerships' (PTPs) as corporations unless 90% or more of their gross income is 'qualifying income.' This bill explicitly states that 'specified carried interest income' is not qualifying income. This means a PTP that earns significant carried interest income would likely lose its pass-through status and be taxed as a corporation, subjecting its income to two layers of tax. A 10-year transitional rule is provided for existing PTPs.
Sec. 3(d) amending IRC Sec. 6662, 6664
40% Penalty for Carried Interest Tax Avoidance
This provision increases the penalty for underpayments of tax related to the avoidance of the new carried interest rules (IRC Section 710(e) or related regulations) from 20% to 40%. It also tightens the 'reasonable cause' exception for this penalty, requiring adequate disclosure, substantial authority for the tax treatment, and a reasonable belief that the treatment was more likely than not proper. This makes it significantly harder to avoid penalties for aggressive tax positions related to carried interest.
Sec. 3(e) amending IRC Sec. 1402, Social Security Act Sec. 211
Self-Employment Tax on Carried Interest Income
This provision amends IRC Section 1402 and Section 211 of the Social Security Act to include 'investment services partnership income or loss' in the calculation of 'net earnings from self-employment.' This means that carried interest income, which is recharacterized as ordinary income under this bill, would also be subject to self-employment taxes (Social Security and Medicare taxes), which are typically applied to earned income from self-employment.
Defines 'specified asset' broadly to include securities, real estate held for rental or investment, interests in partnerships, commodities, cash or cash equivalents, and options or derivative contracts with respect to any of the foregoing. This definition is crucial for determining if a partnership qualifies as an 'investment partnership' subject to the new rules.
Sec. 3(a) (new IRC Sec. 710(c)(4))
Why it matters:It is standard legislative practice to define terms in a dedicated subsection. However, the comprehensive nature of this definition is key to the bill's broad applicability and anti-avoidance strategy.
Case for: Proponents argue that a broad definition of 'specified asset' is necessary to prevent circumvention of the carried interest rules by investing in assets not explicitly listed, ensuring the rules apply across the diverse landscape of investment vehicles.
Case against: Critics might contend that the breadth of the definition could inadvertently capture a wider range of partnerships than intended, increasing compliance burdens and uncertainty for entities not primarily engaged in traditional private equity or hedge fund activities.
Estimated impact: Significantly expands the scope of entities potentially subject to carried interest rules beyond traditional private equity and venture capital, impacting a broader segment of the financial industry.
Provides a limited exception for 'qualified family partnerships' from certain allocation requirements. Specifically, it allows the rule requiring allocations to be made in the same manner as to *unrelated* non-service providers to be relaxed. This means family members who are also service providers can benefit from the qualified capital interest exception even if other capital interests are held by related persons, provided specific conditions are met regarding family ownership and public solicitation.
Sec. 3(a) (new IRC Sec. 710(d)(9))
Why it matters:This is likely a specific carve-out or concession to address concerns that the broad carried interest rules could unduly burden legitimate family-run investment businesses where capital and services are often intertwined among related parties.
Case for: Proponents would argue this prevents the new rules from inadvertently harming traditional family investment offices or businesses, ensuring that genuine capital returns within family structures are not unfairly recharacterized.
Case against: Critics might argue that this provision could create a potential loophole for wealthy families to structure their investment management activities to avoid the full impact of the carried interest rules, potentially undermining the bill's fairness objectives.
Estimated impact: Provides specific relief for a niche group of family-run investment partnerships, potentially reducing the overall revenue impact of the bill slightly and adding complexity to compliance.
This provision includes a 10-year transitional rule, stating that the new rule disqualifying 'specified carried interest income' as qualifying income for publicly traded partnerships (PTPs) shall not apply to any taxable year of the partnership beginning before the date which is 10 years after the date of the enactment of this paragraph.
Sec. 3(c)(6)(E)
Why it matters:Providing a grace period for businesses to adjust to significant new tax rules is a common legislative practice. Its placement ensures it is part of the PTP section without distracting from the main policy change.
Case for: Proponents would argue that this lengthy transitional period allows existing PTPs ample time to restructure their operations, adapt to the new tax regime, or wind down their activities without immediate market disruption or severe financial penalties.
Case against: Critics might contend that a 10-year delay significantly postpones the full revenue and policy impact of the PTP provision, potentially allowing continued avoidance of the intended tax treatment for a substantial period.
Estimated impact: Delays the full fiscal impact of the PTP changes for a decade, reducing immediate revenue gains but mitigating economic shock for affected entities.
This provision repeals Section 1061 of the Internal Revenue Code. Section 1061, enacted in 2017, generally required a 3-year holding period for certain partnership interests to qualify for long-term capital gains treatment, an earlier attempt to address carried interest.
Sec. 3(g)(4)
Why it matters:The new Section 710 effectively replaces and expands upon the intent of Section 1061, rendering the older provision redundant. Its placement as a conforming amendment reflects this, but the policy significance of replacing one carried interest regime with another is substantial.
Case for: Proponents argue that the new Section 710 is more comprehensive and effective in addressing carried interest, making Section 1061 redundant and simplifying the tax code by removing the less effective prior rule.
Case against: No specific opposition is typically raised against the repeal itself, as the new rules are more stringent and comprehensive, effectively superseding the prior, less impactful provision.
Estimated impact: Streamlines the tax code by removing a less comprehensive prior rule, but the overall tax burden on carried interest is significantly increased by the new Section 710, which replaces it.