I don't understand carried interest?

Carried interest is a “bonus” paid to managers of funds (venture capital, PE). A common term is 2 and 20, where 2 is the annual management fee (2%) received by the manager. The 20(%) is the profit (i.e. bonus or carried interest) the manager gets after a certain level of profits are distributed to the fund investors. The investors pay taxes on their distributions using the capital gains rate, as their initial capital was invested at risk.

Problem is that the managers get comparable treatment for those profit distributions, even though they never risked capital, and they were already compensated via the 2% initially. In my mind it’s no different than an employee getting stock grants from their company. The total amount of those grants are taxed at the income tax rate when they vest. This should have been closed years ago, but there’s too much money that flowed to DC to keep it.

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Free888

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Thanks a lot more clear

There is an interesting podcast named “Tax Chats” that discuss carried interest in a recent episode.


The two hosts are professors at Duke and UNC. They generally don’t share their political views but have no problems pointing out political motivations, and they both tend to be of the mindset of “most taxes are for political popularity to remain in power, not because they’re good ideas to raise revenue or change behavior.”

I find it to be quite enjoyable. I had never heard of the concept of carried interest prior to last week, but they left me with a good understanding of it and the history of taxing it.

I equate it to sweat equity kind of. Comp for bringing deals together.

Well I meant what flows down to the individual employees who are compensated with a % of the total carry. But yeah, tomayto tomahto, significant dollars to the entity and personnel.

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I equate it to sweat equity kind of. Comp for bringing deals together.

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That's not related. The issue is not reimbursement. It is tax on the reimbursement.

Let's say you do a standard deal.
Your compensation is $1,000,000.
Uncle Sam will take about $400K of that, and not even tank you for the privilege. You then invest your remaining $600K. At a 7% ROI over 10yrs you end up with $1,208,170. BUT you'll be subject to LTCGs on $608,170, leaving you with $1,068,230.

Now let's say you do a carried interest deal.
Your compensation is $1,000,000 in stock.
Uncle Sam takes none of it until you cash out (lets say 10yrs later in this example). When you do cash out, you do not pay income tax rates. You pay LTCG rates intsead. Assuming your ROI is the same 7% X 10yrs as above, after LTCG taxes you'll end up with $1,550,485.

So two apparently equal compensations for work end up as $1M vs $1.5 d/t income tax vs carried interest.