The Fallacious Objections to the Tax Treatment of Carried Interest

22 Pages Posted: 5 Oct 2016 Last revised: 31 Jan 2017

See all articles by Douglas A. Kahn

Douglas A. Kahn

University of Michigan Law School

Jeffrey H. Kahn

Harry M. Walborsky Professor, Florida State University College of Law; Associate Dean, Business Program

Date Written: October 3, 2016

Abstract

Carried interest is the term used to describe a profits interest in a partnership that invests in entities. A managing partner typically will receive a 20% profits interest in exchange for managing the investments of the partnership. The complaint against the treatment of carried interest is aimed at the characterization of the managing partner's share of the partnership's subsequent capital gains. The contention is that since the managing partner receives her share of the partnership's income for services performed, she should be taxed at ordinary income tax rates rather than the preferentially lower capital gains rate.

The tax treatment of carried interest has become a notorious bete noire for many politicians and some academicians and practitioners. Both presidential candidates have denounced the current tax treatment and vowed to change it. President Obama described the current treatment as a "tax loophole" which should be closed. Others have also characterized the current tax treatment as an abusive loophole. This article takes the contrary position. It is the thesis of this article that those criticisms of the tax treatment are unfounded. To the contrary, the current tax treatment accords with sound tax policy and is proper and appropriate. When the tax treatment of self-created property is considered in the context of the current and proper tax treatment of partners and partnerships, it becomes clear that the allocation of a portion of the partnership's capital gains to the managing partner is not a payment for services and is correctly treated by the managing partner as capital gains.

Keywords: Carried Interest, Capital Gains, Profits Interest, Tax, Partner, Fund

JEL Classification: H2, H24, H25, H26, H29, G24

Suggested Citation

Kahn, Douglas A. and Kahn, Jeffrey H., The Fallacious Objections to the Tax Treatment of Carried Interest (October 3, 2016). Florida Tax Review, Forthcoming, FSU College of Law, Public Law Research Paper No. 818, FSU College of Law, Law, Business & Economics Paper No. 16-15, U of Michigan Public Law Research Paper No. 522, U of Michigan Law & Econ Research Paper No. 16-021, Available at SSRN: https://ssrn.com/abstract=2847148

Douglas A. Kahn (Contact Author)

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4043 (Phone)

Jeffrey H. Kahn

Harry M. Walborsky Professor, Florida State University College of Law; Associate Dean, Business Program ( email )

425 W. Jefferson Street
Tallahassee, FL 32306
United States
850.644.7474 (Phone)

HOME PAGE: http://www.law.fsu.edu/faculty/jkahn.html

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