Taxation of Carried Interest
The taxation of carried interest has been an issue since the mid-2000s, particularly as the compensation earned by certain investors increased along with the sizes of private equity funds and hedge funds. Historically, carried interest has been treated as a capital gain for tax purposes in most geographies. The reason for this treatment is that a fund manager would make a substantial commitment of his own capital into the fund and carried interest would represent a portion of the manager's return on that investment. While hedge funds typically trade their investments actively, private equity firms tend to hold their investments for many years. As such, the capital gains from private equity funds typically qualify as long term capital gains, which receive favorable tax treatment in many geographies. Critics of this tax treatment seek to disaggregate the returns directly related to the capital contributed by the fund manager from the carried interest allocated from the other investors in the fund to the fund manager.
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