Partnership Profits Research Articles

Tax Treatment of 'Carried Interest'

The term ‘‘carried interest’’ is typically used to refer to profits interests issued by investment partnerships to their manager(s). It is an ownership interest in a partnership that has no liquidation value at grant, but entitles the holder to a share in future partnership profits, if any. The term ‘‘carried interest’’ hails from the fact that the ‘‘carried interest’’ holder typically does not invest any of the holder’s own capital in the partnership. Thus, the ‘‘carried interest’’ holder is ‘‘carried’’ by those who do invest capital in the partnership. Currently, the income that a ‘‘carried interest’’ receives is generally taxed as capital gain. Many commentators believe that income allocated by a partnership to ‘‘carried interest’’ holders should be taxed as compensation because the income is for the services the partner performs for the partnership. This paper will examine what the proper tax treatment of ‘‘carried interests’’ should be based on what is the most economically equitable, fair, and efficient method of taxation. Based on the equity and efficiency concepts, the authors suggest that a portion of all ‘‘carried interest’’ income should be taxed as a payment in exchange for services (i.e., as compensation)— regardless of the nature of the underlying assets inside the partnership and regardless of the nature of the business the partnership conducts. However, what qualifies as a ‘‘carried interest’’ and the portion of the income that should be taxed as compensation are not as easily defined.

Determining a Partner's Share of Unrealized Receivables at the Liquidation of the Partner's Interest

Partnership law allows partners great freedom to vary the terms on which they share partnership profits from different sources. Partnership tax law, however, seems to presume, for purposes of the collapsible partner rules, that partners will share the revenue from the collection of receivables always in proportion to the value of their partnership interests. This counterfactual presumption exposes both the government and partner/taxpayers to unfortunate consequences. A substance-over-form approach to the attribution of unrealized receivables would certainly be unworkable, because too costly and intrusive to administer. Something between substance-over form and form-over-substance would best implement the policy of Subchapter K ? an approach modeled on that of the section 704(b) regulations. There is, unfortunately, insufficient legislative authority for the regulatory adoption of such an approach.

Two and Twenty Revisited: Taxing Carried Interest as Ordinary Income Through Executive Action Instead of Legislation

The Treasury Department should issue regulations treating the allocation and distribution of partnership profits in private equity funds — carried interest — as payments for services. My suggested “tax arbitrage” approach uses the presence of tax-exempt limited partners in the investment fund as a proxy for arrangements that inappropriately exploit the difference in tax rates among partners to reduce overall tax liability. The end result of treating carried interest as a payment for services achieves a result similar to the policy recommendation of Two and Twenty: Taxing Partnership Profits in Private Equity Funds, 83 NYU L. Rev. 1 (2008), but it would do so through executive action and without the need for new legislation. A tax arbitrage approach fits seamlessly into the fabric of partnership tax policy. Subchapter K often depends on the adverse interests of partners to guard against abusive tax planning. When adverse interests are not present, special rules often apply. In the case of investment funds, the presence of tax-exempt limited partners is a good proxy for tax arbitrage because an allocation of capital gains to the general partner in lieu of an explicit payment for services is not costly to tax-exempt or tax-indifferent partners, who value the foregone tax deductions at zero. Changing the tax treatment of carried interest by regulation is an appropriate exercise of the delegated legislative authority granted in § 707(a)(2)(A). While new regulations proposed in July 2015 focus almost exclusively on entrepreneurial risk, a close reading of the legislative history from 1984 shows that Congress expected that the managers of an arrangement like a modern private equity fund would be taxed at ordinary rates.

Tax Treatment of “Carried Interest”

ABSTRACT The term “carried interest” is typically used to refer to profits interests issued by investment partnerships to their manager(s). It is an ownership interest in a partnership that has no liquidation value at grant, but entitles the holder to a share in future partnership profits, if any. The term “carried interest” hails from the fact that the “carried interest” holder typically does not invest any of the holder's own capital in the partnership. Thus, the “carried interest” holder is “carried” by those who do invest capital in the partnership. Currently, the income that a “carried interest” receives is generally taxed as capital gain. Many commentators believe that income allocated by a partnership to “carried interest” holders should be taxed as compensation because the income is for the services the partner performs for the partnership. This paper will examine what the proper tax treatment of “carried interests” should be based on what is the most economically equitable, fair, and efficient method of taxation. Based on the equity and efficiency concepts, the authors suggest that a portion of all “carried interest” income should be taxed as a payment in exchange for services (i.e., as compensation)—regardless of the nature of the underlying assets inside the partnership and regardless of the nature of the business the partnership conducts. However, what qualifies as a “carried interest” and the portion of the income that should be taxed as compensation are not as easily defined.

Germany’s Statutory Treatment of Special Payments in Transnational Cases

In the field of business taxation, the German and Austrian concepts of co-entrepreneurship (Mitunternehmerschaft) take special positions. Following these concepts, partnership profits are attributed to partner shares and, accordingly, the partners are taxed independently under the transparency or pass-through principle (Transparenzprinzip) based on their respective shares and the special payments they receive from the partnership. Special payments (Sondervergütungen), for instance, interest on a loan granted to the partnership by a partner, are treated as income from commercial business according to domestic law. Therefore, section 50d, paragraph 10, of the Income Tax Act (Einkommensteuergesetz [EStG]) determines that the special payments are treated as a business profit for treaty purposes. As a result, Germany waives the right to tax the partner as a German permanent establishment (PE). In transnational arrangements, the unique German system often results in conflicts of qualification. On this account, our paper points out the consequences resulting from the treatment of special payments. Based on case studies with inbound and outbound investments, we outline the current status of the German treatment of special payments in transnational dealings and summarize future prospects.

The Government-Citizen Partnership as a New Rationale for Tuition-Free Higher Education

This paper introduces a hypothetical partnership approach to public finance for higher education funding. The paper argues that the partnership between governments and citizens throughout the three life stages of citizens (the learning stage, the working stage, and the retirement stage) can be used as a guiding rationale to support a plan for the full government funding of higher education. During the learning stage of a citizen, the government, as the financing partner of this stage, needs to pay the full cost of all learning levels. After the citizen completes the intended levels of education, the citizen moves to the working stage and starts paying the government partner a share of the partnership profit (income taxes) throughout the working life of the citizen partner. When the citizen partner reaches retirement, the government resumes its financing role through pension payments, old age security payments, or other kinds of payment to help the retired citizen through retirement years. The paper assumes that the relationship between government and its learning citizens extends beyond citizens’ acquisition of knowledge or completion of degrees and includes different periods of funding in which the two sides exchange the funding role throughout the lifetime of a citizen.

The Impact of Increasing Carried Interest Tax Rates on the U.S. Economy

This study looks at recent congressional proposals to increase the tax rate on the general partner's share of a limited partnership's profits, known as carried interest, from the long-term capital gains rate of 15% to ordinary income tax rates of 35%. We show that carried interest is an element of $15.3 trillion in partnership capital used by 16.2 million Americans in every sector of the U.S. economy engaged in capital formation. Increasing the tax rate on carried interest would lead to changes in the structure of partnership agreements; incremental tax collections would be small. To the extent that the tax increase could not be avoided by restructuring, the costs would be borne by all the members of the investment process, including general partners, limited partners and their beneficiaries, as well as owners and employees of portfolio companies. Increasing carried interest taxes would reduce the amount of long-term capital available to the U.S. economy and undermine investment, innovation, entrepreneurial activity, productivity, growth, and the ability of U.S. companies to compete in the global market.

A Medieval Controversy About Profit and Loss Allocations

This paper analyses a controversy between Maimonides and Rabbi Abraham Ben David of Posquierres over the allocation of partnership profits and losses in the absence of a partnership contract. The Maimonidean allocation system depends upon whether the partnership is formed for business or non‐business (consumption) activities. The controversy concerns the notion of indivisibilities in partnership capital. This early debate is analysed in light of the modern—including game‐theoretic—cost allocation literature.

Income Tax Treatment of Shifts in Partnership Profit and Loss Interests

Income Tax Treatment of Shifts in Partnership Profit and Loss Interests

Second Circuit Limits Insider-Partner's 16(b) Liability: Securities Regulation. Liability under Section 16(b) of the Exchange Act Limited to Insider-Partner's Prorata Share of Partnership Profit

Second Circuit Limits Insider-Partner's 16(b) Liability: Securities Regulation. Liability under Section 16(b) of the Exchange Act Limited to Insider-Partner's Prorata Share of Partnership Profit

Partners of Insider Not Accountable under Section 16(b) of Securities Exchange Act but Insider Liable for His Share of Partnership Profits despite His Waiver

Partners of Insider Not Accountable under Section 16(b) of Securities Exchange Act but Insider Liable for His Share of Partnership Profits despite His Waiver

Taxation. Partnership Profits Distributed to Deceased Partner's Estate. Taxation as Income after Previous Subjection to Estate Levy

Taxation. Partnership Profits Distributed to Deceased Partner's Estate. Taxation as Income after Previous Subjection to Estate Levy

Income Taxation. Assignment of Partnership Profits

Income Taxation. Assignment of Partnership Profits

Taxation. Income Tax. Partnership Profits Assigned to Wife Taxable to Husband

Taxation. Income Tax. Partnership Profits Assigned to Wife Taxable to Husband