Carried Interest Fairness Act of 2025
- Bill Number
- H.R. 1091
- Origin Chamber
- House
- Congress
- 119th Congress, Session 1
- Policy Area
- Taxation
- Status
- Introduced
- Latest Action
- 2025-02-06: Referred to the House Committee on Ways and Means.
- Last Updated
- 2025-12-10T06:35:54Z
AI-Generated Summary
Purpose of the Legislation
The Carried Interest Fairness Act of 2025 aims to reform the tax treatment of income earned by individuals providing investment management services through partnerships (pass-through entities). It targets "carried interest," which is a share of profits that investment managers receive as compensation. The goal is to tax this income as ordinary income (subject to higher rates) rather than as capital gains (which receive lower preferential rates), closing what proponents see as a loophole that allows high earners in finance to pay less tax on service-based earnings.
Key Provisions
- Valuation of Partnership Interests for Services (Section 2): When a partnership interest is transferred in exchange for services (e.g., investment advice), its fair market value is calculated as if the partnership sold all assets at current value and liquidated (after liabilities). This value is treated as ordinary income to the recipient in the year received, unless they elect out. Applies to transfers after enactment.
- Special Rules for Investment Services Partnership Interests (Section 3):
- Recharacterization of Income: Adds new Internal Revenue Code Section 710. For "investment services partnership interests" (interests held by those providing services like advising on investments, managing assets, or arranging financing for investment assets such as securities, real estate, or commodities), net capital gains are treated as ordinary income. Net capital losses can be treated as ordinary losses but only up to the amount of previously recharacterized gains.
- Dispositions and Distributions: Gains from selling or gifting such interests are ordinary income (recognized even if other rules defer it). Losses are ordinary but limited. Distributions of property trigger gain recognition as ordinary income, with basis adjusted to fair market value.
- Exceptions:
- Qualified Capital Interests: Portions of interests funded by actual capital contributions (not services) retain capital gains treatment if allocations match those to non-service partners and are significant.
- Family Partnerships: Relaxed rules for closely held family investment partnerships.
- C Corporations: Exempt from recharacterization (except special purpose acquisition companies).
- Elections allow certain exchanges (e.g., mergers) to avoid immediate recognition if reporting requirements are met.
- Other Income: Extends rules to "disqualified interests" (e.g., profit-sharing arrangements) in investment entities, treating related income as ordinary.
- Self-Employment Taxes: Includes recharacterized income in net earnings from self-employment for Social Security and Medicare taxes.
- Publicly Traded Partnerships: Limits "qualifying income" under Section 7704 to exclude carried interest, with a 10-year transition and exceptions for certain real estate or operating partnerships.
- Penalties: Imposes a 40% penalty on underpayments from avoiding these rules (up from 20%), with strict reasonable cause exceptions requiring disclosure, substantial authority, and a "more likely than not" belief in the position.
- Reporting: Requires separate accounting on tax returns for recharacterized items; coordinates with unrealized receivables rules under Section 751.
- Effective Dates: Generally applies to tax years ending after enactment (February 6, 2025 introduction date). Partial-year proration for partnerships; immediate for certain dispositions and other income.
Significant Changes to Existing Law
- Repeal of Section 1061: Eliminates the current three-year holding period rule for carried interest, which deferred preferential capital gains treatment for short-term gains.
- Shift from Capital to Ordinary Treatment: Overrides Section 702(b)'s character preservation for partnership income, forcing service-related gains/losses to ordinary rates (up to 37% vs. 20% max for long-term capital gains). Dividends lose "qualified" status (15-20% rates), and exclusions like qualified small business stock gains (Section 1202) do not apply.
- Expanded Section 751: Treats these interests like "hot assets" (e.g., inventory), triggering ordinary income on indirect dispositions or distributions in tiered partnerships.
- Anti-Avoidance Measures: Introduces look-through rules for tiered entities, attribution of services among related parties, and regulations to prevent circumvention (e.g., via debt mimicking equity). Adds self-employment tax inclusion, previously often excluded for partners.
- Penalty Enhancements: Raises stakes for non-compliance, with narrower defenses than general accuracy-related penalties.
Potential Impacts
- On Government Agencies: The IRS gains authority for new regulations, reporting, and enforcement, potentially increasing administrative workload but boosting tax revenue (estimates vary, but could raise billions annually from higher rates on finance professionals). No direct impact on other agencies.
- On Citizens: Primarily affects high-income individuals in investment management (e.g., private equity, hedge fund managers), who may face 17-20% higher effective taxes on carried interest, reducing after-tax compensation. Could discourage risk-taking in investments or shift structures to corporations. Broader taxpayers benefit indirectly from closed loophole and increased revenue for public services. Low- to middle-income citizens largely unaffected.
- On International Relations: Minimal direct impact, though foreign investment entities or managers with U.S. ties may see higher U.S. tax burdens, potentially affecting cross-border flows. No explicit international provisions.
Main Stakeholders Affected
- Investment Professionals: Partners/managers in hedge funds, private equity, venture capital, and similar firms who earn carried interest; they face higher taxes on performance fees.
- Partnerships and Entities: Investment partnerships (pass-throughs holding assets like stocks or real estate) must adjust allocations, reporting, and structures; publicly traded ones may lose qualifying income status.
- Investors and Limited Partners: Non-service partners (e.g., pension funds, wealthy individuals) may see unchanged treatment for capital contributions but could face indirect effects from fund performance or restructurings.
- IRS and Taxpayers: Enhanced compliance burdens for filers; revenue gains for government.
- Family Offices and Small Entities: Benefit from exceptions, minimizing disruption for non-public family investments.
Notable Legal, Constitutional, or Political Implications
- Legal: Prospective application avoids retroactivity challenges, but complex definitions (e.g., "investment services partnership interest") may lead to litigation over classifications, valuations, or anti-abuse rules. Builds on prior reforms but expands broadly, potentially requiring extensive IRS guidance to clarify ambiguities like "substantially all" assets.
- Constitutional: No major issues; tax classification changes are within Congress's plenary power under Article I. Equal protection concerns (favoring corporations over individuals) could arise but are unlikely to succeed given deference to tax policy.
- Political: Addresses long-standing criticism of tax code favoritism toward Wall Street, promoting "fairness" by aligning service income taxation with wage earners. Likely partisan divide: supporters see equity and revenue; opponents argue it harms capital formation, innovation, and U.S. competitiveness in finance. Could influence broader tax reform debates.
This summary was generated by AI and may contain inaccuracies. Refer to the official source document for the authoritative text.
Sponsor
Rep. Perez, Marie Gluesenkamp [D-WA-3]
Cosponsors (2)
Rep. Beyer, Donald S. [D-VA-8], Rep. Lofgren, Zoe [D-CA-18]
Recent Actions
- 2025-02-06: Referred to the House Committee on Ways and Means.
- 2025-02-06: Introduced in House
- 2025-02-06: Introduced in House
Bill Versions
- Carried Interest Fairness Act of 2025 — issued 2025-02-06 — PDF (45 pages)