Carried Interest – A Possible Loophole for Taxpayers?

Hedge fund managers, or general partners, often work off of a flat fee. The reason for this is a hedge fund is often shared by many partners. As a means of protection, all partners are allotted a share of the fund. This fee is what is considered income for a hedge fund manager. This flat fee comes with carried interest.TaypayerForm

What’s with Carried Interest?

Carried interest is often a larger amount than the management fee. The reason this is considered a loophole is the tax that it saves. A partner’s management fee will be taxed at a high rate. Most partners will owe a high tax rate, on the fee, along with social security, Medicare and other typical employment taxes. With carried interest the tax rate is much lower.

How it Helps

With carried interest taxed at 20 percent, versus 30.6 percent of the management fee, taking home a carried interest is much more financially desirable. By earning mostly carried interest, the partner receives a large sum which is out of the ordinary income tax realm. This is one of the reasons why hedge fund partners make more than most but are taxed at a lower rate than the average person.

Closing the Loophole

Carried interest is a loophole; however it is a loophole typically used by those who are hedge fund managers or work in the capital gains business. Some argue that closing this tax loophole may help the federal budget, taking the pressure off of other Americans. Closing the loophole or leaving it open continues to be a heated debate each tax season.

Image credit: John Morgan

About the author

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

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