President Donald Trump has reignited the debate over the carried interest loophole, a controversial tax break that has been repeatedly renewed on a bipartisan basis. This provision allows investment fund general partners to pay long-term capital gains taxes on carried interest, provided it is held for more than three years. Critics argue that this income should be taxed like regular wages, potentially generating significant federal revenue.
The loophole, widely regarded as a tax break favoring Wall Street, enables top earners to benefit from a 20% capital gains tax rate plus an additional 3.8% net investment income tax. In contrast, the highest tax rate for regular income is set to reach 37% by 2025. Garrett Watson from the Tax Foundation describes the ongoing discussion as a "fascinating challenge," highlighting the complexity of the issue.
"It's come up again and again on a bipartisan basis," – Garrett Watson, director of policy analysis at the Tax Foundation.
Eliminating this tax break could bolster federal finances. The Congressional Budget Office estimated in December that taxing carried interest as regular income could reduce the federal budget deficit by $13 billion over ten years. However, efforts to amend the loophole have seen limited success. The Tax Cuts and Jobs Act of 2017 extended the holding period for long-term capital gains treatment from more than one year to three years. A proposal to extend this period to five years was considered during discussions for the Inflation Reduction Act in 2022 but did not come into effect.
The American Investment Council, representing private equity interests, firmly opposes any changes to the carried interest provision. They argue that this tax treatment is crucial for incentivizing investment fund managers who derive part of their earnings through a share of the fund's profits known as carried interest.
"The carried interest loophole is a fascinating challenge," – Rosenthal.
The carried interest debate highlights the broader tension between taxation policy and economic incentives within the financial sector. Proponents of change assert that treating carried interest as regular income aligns with equitable tax principles. Meanwhile, opponents emphasize the potential impact on investment strategies and economic growth.