Carried Interest Tax Rules Get a Major Overhaul in New Bill: Effective Immediately

The "Carried Interest Fairness Act of 2025" just dropped, and it's shaking up how investment managers get taxed. This bill changes the game for partners in investment firms, specifically targeting that controversial "carried interest" – basically, a share of the profits. Here is the breakdown.

Rewriting the Rules for Investment Income

This bill fundamentally changes how income from investment services partnership interests is taxed. Instead of enjoying the lower capital gains tax rate, net capital gains are now treated as ordinary income (SEC. 3). Think of it like this: if you're a teacher, your salary is taxed as ordinary income. This bill says the profits from managing investments should be treated the same way. Also, any losses are treated as ordinary losses, but only up to the amount of gains you've already reclassified (SEC. 3). This means you can't use these losses to offset other types of income beyond what you made through carried interest.

For example, imagine a hedge fund manager who previously paid a 20% capital gains tax on their carried interest. Now, that income could be taxed at rates up to 37%, depending on their total income. This change applies to taxable years ending after the bill's enactment (SEC. 3), so it's happening fast.

Valuing Partnership Interests – No More Guesswork

When a partner gets a partnership interest in exchange for services, the bill sets a clear way to value it: It's what the partner would get if the partnership sold everything at fair market value and liquidated (SEC. 2). This is important because it determines the income the partner has to report. And, generally, they must include it in their income that year (SEC. 2). This prevents some of the fancy accounting tricks that could minimize tax bills in the past.

Red Flags and Exceptions

There are a few key things to watch:

• "Investment Services Partnership Interest" Definition: This is the core of who's affected. It covers anyone providing investment-related services, like advising, managing assets, or arranging financing (SEC. 3). The devil's in the details, and how this is interpreted will matter a lot.
• "Qualified Capital Interest" Exception: If a partner's interest is genuinely based on their own capital contributions and allocations are similar to those of non-service partners, some of these rules don't apply (SEC. 3). This could be a loophole, depending on how it's structured.
• C-Corp Exemption: These rules generally don't apply to regular C corporations (except for SPACs) (SEC. 3). This might lead some firms to restructure.
• 40% Penalty: If you try to get around these rules and underpay your taxes, there's a hefty 40% penalty (SEC. 3). That's a big stick to encourage compliance.

Real-World Impact

This bill directly hits the wallets of investment managers, particularly those in private equity and hedge funds. It aims to level the playing field, ensuring they pay taxes on their profits at rates similar to other high-income earners. The big question is whether this will change investment behavior, lead to creative restructuring, or simply generate more tax revenue. The broad authority given to the Secretary to issue regulations (SEC. 3) means the specifics could shift, so this is one to watch closely.