The Taxation of Private Equity Carried Interests: Estimating the Revenue Effects of Taxing Profit Interests as Ordinary Income

Abstract:     
In this Article, I estimate the tax revenue effects of taxing private equity carried interests as ordinary income rather than as long-term capital gain as under current law. Under reasonable assumptions, I conclude that the expected present value of additional tax collections would be between 1 percent and 1.5 percent of capital invested in private equity funds, or between $2 billion and $3 billion a year. That estimate, however, makes no allowance for changes in the structure of such funds or the composition of the partnerships, which might substantially reduce tax revenues below those estimates.

Keywords: private equity, profits interest, carried interest, carry, taxation of capital, taxation of services, capital gains, ordinary income, capital gains preference, tax deferral, stock-based compensation, equity-based compensation, option pricing, Black-Scholes formula, tax revenue estimation, H.R. 2834

JEL Classifications: H2, H25, D2, D3, D6

Working Paper Series