Ending the Carried Interest Loophole Act
- Sponsor
- Sen. Wyden, Ron [D-OR]
- Committees
- Finance Committee (primary)
- Last action
- Apr 16, 2026
Bottom line
This bill aims to increase the ordinary income tax burden on certain investment managers' profits, treating a portion of their carried interest as annual compensation rather than capital gains.
What it actually does
This bill significantly revises the tax treatment of partnership interests received in connection with the performance of services, commonly known as 'carried interest.' It mandates that the fair market value of such interests be included in gross income at the time of transfer, unless an explicit election is made otherwise. Crucially, it introduces a new annual 'deemed compensation amount' for applicable partnership interests, which is taxed as ordinary income, with a corresponding long-term capital loss. The bill also repeals the existing Internal Revenue Code Section 1061, which currently recharacterizes certain short-term capital gains from carried interest.
Proponents argue
Supporters argue the bill closes a significant tax loophole that allows wealthy fund managers to pay lower capital gains rates on income that is effectively compensation for services, rather than a return on invested capital. They contend it promotes tax fairness and ensures that income derived from labor is taxed at ordinary income rates, aligning with the principle of equal taxation for similar economic activities.
Opponents contend
Opponents typically argue that carried interest represents a return on risk-taking and long-term investment, not ordinary income, and taxing it as such would stifle investment, harm capital formation, and make the U.S. less competitive. They may also contend that the proposed 'deemed compensation amount' creates complex and potentially punitive annual tax liabilities on unrealized income, hindering the ability of fund managers to invest in new ventures.
The bill is short, but its technical nature and amendments to the Internal Revenue Code require careful reading and understanding of existing tax law to fully grasp its implications.
Section 2(a), amending IRC Section 83(c)
Immediate Taxation of Partnership Interests Received for Services
This provision generally requires that when a person receives an interest in a partnership for performing services, the fair market value of that interest must be included in their gross income immediately. The value is determined as if the partnership sold all its assets for cash and distributed the proceeds. The recipient is treated as having made an election to include this value in income, unless they explicitly elect *not* to.
Supporters argue
Supporters argue this ensures that the value of an interest received for services is taxed upfront, preventing deferral and aligning with the treatment of other forms of compensation for labor.
Critics contend
Opponents might argue this creates an immediate tax burden on an illiquid asset, potentially forcing recipients to sell portions of their interest or seek complex financing, which could hinder participation in partnerships and disincentivize entrepreneurial activity.
Tradeoffs
This provision balances the goal of immediate taxation of compensation for services with the practical challenges of taxing illiquid assets that may not generate immediate cash flow for the recipient.
Section 3(a), adding new IRC Section 1299(a)
Annual Ordinary Income Inclusion for Carried Interest
For taxpayers holding 'applicable partnership interests,' this provision requires an annual inclusion in gross income of a 'deemed compensation amount' as ordinary income. Simultaneously, the taxpayer recognizes a long-term capital loss of the same amount. This effectively recharacterizes a portion of the capital gains from carried interest as ordinary income each year, subject to higher tax rates, while the capital loss may have limited utility.
Section 3(a), adding new IRC Section 1299(b)
Scope of Carried Interest Subject to New Rules
This section defines what constitutes an 'applicable partnership interest' subject to the new rules. It includes interests directly or indirectly transferred for services in an 'applicable trade or business' and interests held by a taxpayer who received an 'applicable loan.' It also expands the definition to include certain financial instruments or interests in other entities that function similarly to partnership interests, aiming to prevent avoidance through alternative structures.
Section 3(a), adding new IRC Section 1299(b)(3)
Activities Covered by Carried Interest Rules
This defines an 'applicable trade or business' as an activity conducted regularly and substantially that involves 'raising or returning capital' and either 'investing in' or 'developing specified assets.' 'Specified assets' include securities, commodities, and real estate held for rental or investment. This definition limits the application of the new rules to investment management activities, distinguishing them from other types of businesses.
Section 3(b)
Repeal of Existing Carried Interest Rules (Section 1061)
This section repeals Internal Revenue Code Section 1061, which currently recharacterizes certain long-term capital gains from 'applicable partnership interests' as short-term capital gains if the asset holding period is three years or less. The new Section 1299 effectively replaces and expands upon the intent of Section 1061, making the prior provision redundant.
This provision defines an 'applicable loan' as a loan issued directly or indirectly from the partnership, any other partner, or related persons, unless it is fully recourse to the borrower and requires interest payments at a specified rate. If a partner receives such an 'applicable loan,' their 'invested capital' (which reduces the 'deemed compensation amount') is reduced by the amount of that loan.
Section 3(a), IRC 1299(b)(4) and 1299(c)(4)(C)
Why it matters:It is standard legislative practice to define terms and their implications within the relevant sections. However, the indirect effect on the 'deemed compensation amount' through the 'invested capital' calculation makes it less immediately obvious to a casual reader.
Case for: Proponents argue this prevents partners from artificially inflating their 'invested capital' through non-recourse or below-market loans from the partnership, thereby reducing their deemed compensation and tax liability. It is an essential anti-abuse measure to ensure the integrity of the new tax regime.
Case against: Critics might argue that legitimate financing arrangements could be inadvertently caught by this definition, especially if the 'specified rate' is set too high or if the recourse requirements are overly strict, potentially hindering common business practices and partnership formation.
Estimated impact: This provision prevents a potential avenue for tax avoidance, ensuring that the 'deemed compensation amount' calculation is based on genuine at-risk capital, thereby increasing the effective tax burden for those who might otherwise use such loan structures.
If a taxpayer disposes of any portion of an 'applicable partnership interest' during a taxable year within a 10-year 'applicable period,' the 'deemed compensation amount' for that year is increased. This increase is calculated based on the difference between the current year's deemed compensation and the amount determined without the disposition, multiplied by the number of remaining taxable years in the applicable period. This effectively accelerates future deemed compensation into the year of disposition.
Section 3(a), IRC 1299(c)(5)
Why it matters:This is a technical detail for a specific event (disposition) that is crucial for preventing avoidance through early sale, but it is not central to the annual calculation. Its placement is typical for anti-avoidance provisions that address specific taxpayer behaviors.
Case for: Proponents argue this prevents taxpayers from selling their interests prematurely to avoid the full impact of the annual deemed compensation rules, ensuring that the policy's intent is maintained over a reasonable holding period and that the tax is ultimately paid.
Case against: Opponents might argue this creates an additional layer of complexity and a potentially significant, unexpected tax burden upon disposition, especially if the disposition is for reasons unrelated to tax avoidance (e.g., retirement, unforeseen circumstances, or market downturns).
Estimated impact: This provision discourages early disposition of applicable partnership interests and ensures a more consistent application of the deemed compensation rules over time, potentially leading to higher tax liabilities in the year of disposition for affected taxpayers.
This bill grants broad authority to the Secretary of the Treasury to prescribe regulations and other guidance necessary to carry out the new provisions. This includes preventing abuse (e.g., through income allocation to tax-indifferent parties or manipulation of invested capital), applying rules to financial instruments and non-partnership entities, aggregating or disaggregating assets, handling tiered structures, and addressing loan forgiveness and non-recognition transfers (like gifts or inheritances).
Section 2(a), IRC 83(c)(4)(D)(ii) and Section 3(f)
Why it matters:It is common legislative practice to grant regulatory authority for complex tax legislation, as it allows the Treasury to adapt to evolving financial structures and address unforeseen issues. However, the extensive scope here means significant policy details will be shaped post-enactment.
Case for: Proponents argue that broad regulatory authority is essential for tax legislation of this complexity to adapt to evolving financial structures, prevent unforeseen loopholes, and ensure the effective implementation and enforcement of the law.
Case against: Critics might express concern that such broad authority could lead to regulations that go beyond congressional intent, creating uncertainty for taxpayers and potentially imposing burdens or interpretations not explicitly debated by Congress, effectively giving the executive branch significant policymaking power.
Estimated impact: This provision gives the Treasury Department significant power to shape the practical application, interpretation, and enforcement of the new carried interest rules, which will heavily influence compliance obligations and tax liabilities for affected taxpayers.