The topic of “carried interest” has come up quite a bit during this presidential campaign with several candidates vowing to get away from it once they are in office. So, what exactly is carried interest? Why is it generating such high-profile attention?
Carried interest, or “carry,” is a profits interest in a partnership, as used in venture capital, private equity and hedge funds environments. Typically, upon formation of such a partnership, an individual or a group of individuals are hired to manage the fund. They are compensated with a management fee, most commonly equal to 2% of the assets being managed. Additionally, they might receive a right to 20% of the future profits of the fund.
It is that profits interest that is commonly referred to as “carried interest.” A profits interest is usually received tax free, as it has no value when awarded. On the other hand, when capital investment is awarded, it has a definite value (i.e., the capital account received), and the receipt of a capital account is generally a taxable event.
A profits interest holder is usually allocated long-term capital gains and qualified dividends, which are taxed at a maximum of 20% tax rate.
Most successful funds can generate enormous profits. The concern expressed by this election season’s presidential candidates is that the profits received from carry are effectively a salary to the investors; but they are not taxed at the ordinary 39.6% marginal tax rates that an average person would have to pay on such income.
For more information on carried interest please contact Stella Metz, CPA, MST, MBA at firstname.lastname@example.org or 813-386-3867.