Institutional Investor Magazine

Unconventional Wisdom: The Impending Death of Carried Interest

by Perry Lerner, Chairman & CEO of Crown Global

"The hedge fund guys are getting away with murder," Republican presidential candidate Donald Trump said in an interview on the Sunday-morning news program Face the Nation. All of his potential Democratic opponents agree with this sentiment — not to mention members of his own party, like Jeb Bush. What they are referring to is taxes paid on what is commonly known as carried interest, that portion of a fund manager's compensation based on the profits of the fund.

Common industry practice is to compensate portfolio managers by paying ongoing management fees based on the amount under management, usually 1 to 2 percent of the assets, plus a share of the fund's profits, typically 20 percent. Ongoing management fees are taxed at standard corporate income tax rates, usually 39.8 percent. Income related to the carried interest generally retains the character of the underlying fund investments, much of which represents long-term capital gains, taxed at a lower rate of 23.5 percent. This disparity in tax rates for seemingly similar activity is now in the bull's-eye of both political parties. The question is no longer whether this disparity will end — but when and how.

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