The "Carried Interest Fairness Act of 2025" changes the tax treatment of certain partnership interests related to investment services, reclassifying capital gains as ordinary income and imposing stricter rules to ensure fair taxation.
Tammy Baldwin
Senator
WI
The "Carried Interest Fairness Act of 2025" changes the tax treatment of certain partnership interests, especially those related to investment management services. It reclassifies certain capital gains as ordinary income for partners providing these services, modifies the valuation and tax implications of partnership interests transferred for services, and introduces stricter rules to prevent tax avoidance. This act aims to ensure that income derived from investment management is taxed at ordinary income rates rather than more favorable capital gains rates. It also includes provisions addressing qualified dividend income, gains from qualified small business stock, and the treatment of income from special purpose acquisition companies.
Carried Interest Fairness Act of 2025: Investment Managers Face Higher Taxes on Profits
The Carried Interest Fairness Act of 2025 shakes up how investment managers' profits are taxed. Instead of the lower capital gains rate, some of that income will now be taxed as regular income, potentially increasing their tax bill. This change kicks in for partnership interests transferred after the bill becomes law (SEC. 2). For investment service partnership interests, taxable years ending after the date of enactment will be affected (SEC. 3).
Rewriting the Rules for Investment Income
This bill targets partners who provide "investment management services" to partnerships. If you're managing investments and get a cut of the profits (a "carried interest"), this could hit your wallet. The Act reclassifies certain capital gains as ordinary income, meaning a potentially higher tax rate (SEC. 3). It also gets specific about what counts as an "investment services partnership interest" and an "investment partnership," focusing on the types of assets held and the nature of the capital (SEC. 3).
For example, if a real estate manager earns a percentage of the profits from flipping a property portfolio, that income could be subject to the higher ordinary income tax rates, rather than the lower capital gains rates, depending on the particulars of their partnership agreement. There are also provisions to limit the ability to offset these gains with losses.
New Penalties and Exceptions
To keep things on the level, the bill slaps a 40% penalty on underpayments if you're trying to dodge these new rules (SEC. 3). However, there's an exception for "qualified capital interests," where gains and losses are allocated the same way for all partners, regardless of whether they're providing services (SEC. 3). This could become a point of contention, potentially creating complex structuring scenarios.
Also, regular C corporations (but not Special Purpose Acquisition Companies or SPACs) are exempt from some of these provisions (SEC. 3). This might make the C-corp structure more appealing for some investment setups.
What it Means for Regular Folks
While this bill primarily targets high-earning investment managers, it could have broader ripple effects. The increased tax revenue could, in theory, fund government programs. However, it’s also possible that altered investment strategies could change the landscape of available investment opportunities for everyone, from those running small businesses to those working in the trades. The changes to Section 7704 of the tax code, which deals with publicly traded partnerships, could even have implications for retirement accounts, although the specifics would depend on the individual investments held within those accounts. The bill also amends several sections of the Internal Revenue Code (SEC. 3), so figuring out all the downstream effects will take time.