Tax Carried Interest as Ordinary Income

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2023–
Decrease (-) in the Deficit -0.9 -1.3 -1.2 -1.1 -1.1 -1.1 -1.2 -1.2 -1.2 -1.2 -5.6 -11.5

Data source: Staff of the Joint Committee on Taxation.

This option would take effect in January 2023.

Investment funds—such as private equity funds, real estate funds, and hedge funds—are often organized as partnerships. Those partnerships typically have two types of partners: general partners and limited partners. General partners manage investment funds and typically receive two types of compensation: a management fee tied to a percentage of the fund's assets and a percentage of the fund's profits, which is called carried interest. Carried interest associated with gains from the sale of an asset held for more than three years is usually taxed at the long-term capital gains rate, which is typically lower than that for ordinary income. Additionally, carried interest is not subject to the self-employment tax.

This option would treat carried interest that general partners receive for performing investment management services as labor income, taxed at the rate of ordinary income and subject to the self-employment tax. Income those partners received as a return on their own capital contribution would not be affected.