Private equity, hedge funds brace for carried interest Washington tax fight

As Republicans and Democrats vie for control of the White House and Congress, private equity, hedge fund and venture capital trade groups are gearing up for the upcoming fight over tax policy and are keen on preserving a benefit they contend is critical to their industries’ ecosystem.

Many of the provisions in the Republican’s 2017 Tax Cut and Jobs Act expire next year, so one of the main policy debates in 2025 will center on whether those provisions should be extended, amended or be allowed to lapse, and how — if at all — the package should be paid for, sources said.

And while the tax treatment of carried interest isn't one of the expiring provisions, hedge fund industry group the Managed Funds Association, or MFA, is gearing up for yet another round of debate, said Jillien Flores, executive vice president and managing director, and head of global government affairs.

Carried interest treats income flowing to a private fund's general partner as capital gains, which are subjected to a lower tax rate — capped at 20% — as opposed to the top individual income tax bracket — 37%.

It is a performance-based share of profits from a private fund paid to the fund's general partner. Carried interest's preferential tax rate is especially important for private funds and their managers, according to the Urban-Brookings Tax Policy Center. The general partner receives its carried interest as compensation for its investment management services; typically the split is 20% of the profits to the general partner and 80% to the limited partners, the Tax Policy Center notes.

The debate around carried interest is nothing new to Washington (and the U.K.). In recent years, both former President Donald Trump and President Joe Biden have called on Congress to end carried interest.

In Democrats’ party platform that was released Aug. 19, it said the party will “close the ‘carried interest’ loophole, which wealthy fund managers have long used to halve tax rates on their own personal pay, so they pay a lower rate than some teachers or firefighters do.”

And the Committee for a Responsible Federal Budget on Aug. 16 reported that the Harris campaign said the vice president supports all of the revenue-raising provisions in the President Biden’s fiscal year 2025 budget, which includes eliminating carried interest.

But though changes have been made in the recent past to carried interest, it has survived previous tax policy debates.

Changes since 2017

The 2017 tax bill that Republicans passed and Trump signed into law did not end carried interest but required fund managers to hold underlying investments for at least three years instead of one.

In 2022, when Democrats passed the Inflation Reduction Act that Biden signed into law, lawmakers debated extending the hold period to five years, but the provision was removed before the bill’s final passage.

"I would be surprised if there aren’t proposals out there next year that seek to extract more taxes from our members as a pay-for for something else,” Flores said. “MFA’s focus during the tax debate will remain on ensuring any changes to the tax code do not have the unintended consequence of reducing investment in our economy.”

In May, the Congressional Budget Office estimated that it would cost $4.6 trillion over 10 years to extend the expiring 2017 tax cuts.

The provisions set to expire mostly affect individuals, such as increases in both the standard deduction and the size of the child tax credit. The 2017 bill also cut the corporate tax rate to 21% from 35%, but that provision was permanent and can only be changed through additional legislation.

Sources said they expect all tax policy to be up for discussion next year, but with narrow majorities likely — no matter which party wins control of the White House and Congress — and a desire to preserve big programs like Social Security, Medicare and Medicaid, finding money to offset the $4.6 trillion figure will be difficult.

"You’re really left searching for nickels and dimes in the couch cushions to offset some of these tax proposals that are, quite frankly, very popular and important to voters,” said Caroline Schellhas, vice president of government affairs at the National Venture Capital Association.

NVCA is preparing for any governing scenario that could happen next year as it mounts its defense of carried interest, which Schellhas described as the main incentive for general partners to invest in funds.

"It's the incentive that really drives these high risk-type investments that you generally can’t get through a traditional lending source like a bank because they’re very high risk," Schellhas added.

And because many startup companies fail, the carried interest deduction “really incentivizes making those risky decisions knowing that there may be a capital gains benefit on the other end,” she said.

Drew Maloney president and CEO of the American Investment Council, which represents the private equity industry, said he supports the current carried interest tax policy established in 2017. “It encourages long-term investment and aligns the interest of your investors" and of the general partner, he said.

Regarding calls to further tax carried interest or scrap it entirely, Maloney said: "It’s a camel’s nose under the tent of eliminating capital gains all together."

But many Democrats in Congress view carried interest differently. In April, a group of Senate Democrats reintroduced a bill to do away with the framework.

One of the bill’s sponsors, Sen. Sherrod Brown, D-Ohio, chair of the Senate Banking Committee, said in a statement accompanying the bill’s introduction that the carried interest “loophole is yet another way wealthy special interests have rigged the system to work for them, at the expense of everyone else. Hedge funds and private equity firms shouldn’t pay less taxes than working people in Ohio.”

Brown is in the midst of a tough reelection campaign as Democrats fight to preserve control of the Senate.

Whether Trump or Vice President Kamala Harris wins the November election, the margins for controlling the House and Senate are almost certain to be narrow and movement on carried interest will be difficult, said Benjamin R. Page, a senior fellow at the Urban-Brookings Tax Policy Center.

If Democrats sweep the White House, Senate and House, it’s possible they move on carried interest, but it’s far from a certainty, Page added.

If Republicans retain control of the House, debate around carried interest is a “non-starter,” Page added.

Trump “had four years and didn’t do it,” Page said regarding nixing carried interest.

“Biden had four years and didn’t do it. Whether how much of that was will and how much of that was just what you were able to get through Congress is hard to decipher, how badly the administrations were really trying. It doesn’t seem like something that’s a popular thing in Congress to close that loophole; it seems to be difficult to get done,” he said.