On December 9, 2009, the House of Representatives passed the “Tax Extender Act of 2009” (the “Bill”), the primary purpose of which is to extend numerous tax provisions scheduled to expire as of December 31, 2009. In order to offset the reduction in tax revenues attributable to the extended provisions, the Bill, which would apply to taxable years ending after December 31, 2009, includes (i) a provision changing the tax treatment of the “carried interest” (such as an incentive allocation) derived by a general partner (“General Partner”) of a private investment partnership (“Investment Partnership”), and (ii) includes most of the tax provisions contained in the “Foreign Account Tax Compliance Act of 2009”, a bill introduced in late October in the House and Senate. The fate of the Bill remains uncertain since the Senate Finance Committee has not yet formally addressed the issue of the expiring tax provisions.

Under current law, the “carried interest” derived by a General Partner of an Investment Partnership (i.e., an allocation of an Investment Partnership’s income that is disproportionate to the capital invested by the General Partner in the Investment Partnership) has the same federal income tax characterization (e.g., capital gain or ordinary income) as the tax character of the income derived by the Investment Partnership. Further, because the “carried interest” is treated as an allocation of the profits of the Investment Partnership, the “carried interest” currently is not treated as “self-employment income” to the General Partner for purposes of the self-employment tax.

Under the Bill, the “carried interest” income derived by a General Partner of an Investment Partnership would in all instances be treated as ordinary income and would also be subject to self-employment tax. As under current law, under the Bill the portion, if any, of the “carried interest” attributable to the Investment Partnership’s unrealized gains would not be subject to tax until such gains are realized. Under the Bill, partnership “flow-through” tax treatment would continue to apply to a General Partner’s allocable share of income from an Investment Partnership that is allocated based on capital the General Partner has actually contributed to the Investment Partnership. In addition, under the Bill, any gain derived by a General Partner on the disposition of its equity interest in an Investment Partnership (other than the portion of gain attributable to the General Partner’s contributed capital) would be treated as ordinary income, rather than as capital gain.

If you have any questions regarding this Memorandum, please contact Dan Murphy (212-574-1210), Peter Pront (212-574-1221), Ron Cima (212-574-1471) or Jim Cofer (212-574-1688) of our Tax Group.