On February 6, 2025, Democratic Senators and Representatives proposed the Carried Interest Fairness Act, which would treat carried interest as ordinary income. Additionally, on the same day President Trump met with Congressional Republican leadership and discussed ending the favorable tax treatment of carried interest. With Congress expected to extend various provisions of the 2017 Tax Cuts and Jobs Act, this proposed bill and announcement from President Trump’s Press Secretary clearly signal that the tax treatment of carried interest is again in the crosshairs with potential alignment between the parties.
With respect to carried interest, the proposal would treat all capital gains as ordinary income and shut off the advantageous tax treatment of qualified dividends and qualified small business stock. It appears that “60/40” treatment for section 1256 contracts is not affected, though that could change as the proposed legislation works its way through the legislative process. Note that the currently effective constraint on carried interest under section 1061, which treats gains from the sale of property held three years or less as short-term capital gains, does not affect the tax treatment of qualified dividends, section 1256 contracts or qualified small business stock.
The proposal would tax gain on the disposition of an investment services partnership interest as ordinary income (instead of the current long term capital gains treatment if underlying assets are held for longer than three years). In addition, a partner would generally be required to recognize gain upon a distribution of property from an investment services partnership, at ordinary income rates to the extent a sale of the partnership’s underlying assets would have been taxed as ordinary income to the partner under the proposal.
Similar to section 1061, the proposal provides for a capital interest exception provided certain requirements are met. It also provides that investment services partnership income is subject to self-employment taxes (but not with respect to a partner’s qualified capital interest).
In addition, the proposal would codify the current IRS treatment of profits interests, treating the fair market value of a profits interest as equal to its liquidation value at the time of transfer. It would also deem a section 83(b) election to be made for a profits interest, unless the recipient of the interest affirmatively elected not to have section 83(b) apply. This will eliminate uncertainty regarding the treatment of profits interests and the need to make a protective section 83(b) election for such interests.
Final Remarks
Seward & Kissel LLP actively monitors tax changes and their impact on the investment management industry. For additional information, please contact a member of Seward & Kissel’s Tax Group.
