Fuzzy Math and Carried Interests: Making Two and Twenty Equal 710

Abstract

This report explores proposed section 710 (as modified and reintroduced by H.R. 4213), which would treat the compensatory portion of a service partner's return as ordinary income. The report suggests an alternative distribution-based approach, modeled on section 707(a)(2)(A), which would accomplish section 710's goal of preventing conversion of ordinary income into capital gain and also address the issue of tax deferral. The report starts from the premise that the carried interest problem should be understood as a specialized form of joint tax arbitrage that exploits differences in the partners' tax profiles. It then applies an approach to tax deferral that is already well established in the area of deferred compensation. Within this analytical framework, the report argues that abusive carried interest arrangements can best be addressed by modest revisions to section 707, without enacting complex new provisions of uncertain scope. The report builds on Professor Burke's previous work, Back to the Future: Revisiting the ALIs Carried Interest Proposals, Tax Notes, Oct. 12, 2009, p. 242, Doc 2009-20453, or 2009 TNT 196-6, and The Sound and Fury of Carried Interest Reform,1 Colum. J. Tax L. 1 (2010).

Keywords: partnership, profits interest, carried interest

JEL Classification: K34