Investment fund managers — hedge fund, private equity, and venture capital professionals — currently pay the lower long-term capital gains tax rate (maximum 20%) on a share of their fund's profits called "carried interest," even though it is compensation for services, not investment of their own money. The Carried Interest Fairness Act of 2025 would close that gap by recharacterizing all carried interest gains as ordinary income, taxed at rates up to 37%, regardless of how long the underlying assets were held. It repeals the existing partial reform (IRC § 1061, which required only a 3-year holding period for the lower rate) and replaces it with a comprehensive new statute — IRC § 710 — that covers income, dispositions, and distributions from investment services partnership interests. The bill also subjects carried interest income to self-employment taxes (Social Security and Medicare), blocking a separate layer of tax avoidance. Additional anti-gaming rules prevent managers from using the qualified small business stock gain exclusion on carried interest, and block a step-up in tax basis at death from erasing the ordinary income that would have been owed. Managers who try to structure around these rules face a 40% accuracy-related penalty — double the standard 20% rate — with a tighter reasonable-cause exception that requires disclosure, substantial legal authority, and a good-faith belief the treatment was correct.
Corporate Benefits
- Capital gains preference on carried interest — recharacterizes fund managers' profit share as ordinary income, taxed at rates up to 37% instead of the current 20% capital gains rate
- Carried interest self-employment tax exemption — closes the gap that allowed investment managers to avoid Social Security and Medicare taxes on carried interest income
- Qualified small business stock exclusion for carried interest — bars managers from applying the § 1202 gain exclusion to QSBS gains allocated through an investment services partnership interest
- Basis step-up at death on investment services partnership interests — treats unrealized ordinary income as income in respect of a decedent, preventing heirs from inheriting a tax-free stepped-up basis
Transparency & Accountability
- Accuracy-related penalty for carried interest avoidance — doubles the standard penalty to 40% for underpayments resulting from structuring around the new carried interest rules
- Reasonable-cause exception standard for carried interest — requires adequate disclosure, substantial legal authority, and affirmative good-faith belief, a higher bar than the standard exception
Congressional Summary
Carried Interest Fairness Act of 2025This bill taxes income from carried interest at ordinary income tax rates and makes other changes related to carried interest. (Some exceptions apply.)As background, a general partner in a private equity firm or hedge fund (typically structured as a partnership) generally receives a share of the profits from the assets managed by the general partner (known as carried interest). Under current law, carried interest is characterized (for federal tax purposes) as an interest in a partnership’s capital and, thus, taxed at capital gains tax rates (which may be lower than the applicable ordinary income tax rates). Under the bill, net capital gain and loss attributable to carried interest is recharacterized as ordinary income and loss and, thus, taxed at ordinary income tax rates. (Some exceptions apply.)The bill also treats as ordinary the money (or fair market value of property) received by a partner in a sale or exchange of carried interest. (Thus, the bill extends what is known as the hot asset rule to include carried interest.)Further, the bill deems distributions of carried interest by a partnership in exchange for interest in other partnership property a sale or exchange of such property and, thus, requires the partner to recognize ordinary gain on the distributed carried interest.Finally, the bill imposes self-employment taxes on carried interest income.
Details
- Congress
- 119th
- Chamber
- House
- Status
- summarized
- Action
- Introduced in House
- Action Date
- 2025-02-06
- Date Added
- 2026-06-05
- Source
- Congress.gov →
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