The Sound and Fury of Carried Interest Reform

Of all the proposals advanced in recent years to reform Subchapter K, the part of the Internal Revenue Code governing partnership tax, perhaps none has generated more acrimony and confusion than the pending carried interest legislation contained in proposed § 710. While reformers have framed the issue of taxing the compensatory portion of a service partner\u27s return as ordinary income in terms of distributive justice, critics have been quick to invoke the rhetoric of class warfare to fend off reform. In the most elementary terms, the carried interest legislation would tax some (but not all) of a service partner\u27s share of partnership profits as ordinary income. Even at this basic level, however, the contours of the proposed legislation are ambiguous. Indeed, the reform is sometimes misdescribed as taxing distributions rather than distributive shares as ordinary income, a distinction that is fundamental. Moreover, the precise tax advantage of carried interest arrangements depends crucially on whether one adopts a joint-tax perspective or focuses more narrowly on the service partner\u27s opportunity for deferral and conversion. Apart from the merits of carried interest legislation, there is also considerable dispute over whether such reform is likely to raise significant amounts of revenue