Inflation Reduction Act targets carried interests

On July 27, US Senators Joe Manchin and Chuck Schumer announced proposed legislation referred to as the Inflation Reduction Act of 2022 (the Act). The proposed legislation includes changes that would expand the scope of IRC section 1061, which generally imposes limits on tax benefits available to carried interests and other compensatory partnership interest arrangements.

By way of background, carried interest arrangements have long been used by private investment funds, including private equity, real estate, hedge funds and other alternative asset management funds, as a way to compensate and incentivize fund managers. The carried interest typically is issued to the fund manager as a non-taxable equity interest in the fund that entitles the fund manager to share in future profits of the fund. The issuing fund is classified as partnership (a pass-through entity) for tax purposes, and the pass-through treatment of the fund allows the fund manager’s share of fund capital gains to be taxed to the fund manager as long-term capital gain that is eligible for preferential capital gains rates, notwithstanding that the fund manager is issued the carried interest as consideration for services.