Senate Democrats Propose Carried Interest Tax Reform

On July 27th, 2022, Senator Joe Manchin (D-W.Va.) and Senate Majority Leader Chuck Schumer (D-N.Y.) announced they had reached an agreement on a reconciliation bill, known as the “Inflation Reduction Act of 2022” (the “Act). If passed, the Act would change the tax treatment of carried interest (the “Carried Interest Changes), making it more difficult to qualify for long-term capital gain treatment. The Act contains other provisions regarding corporate taxation, healthcare reform, and clean energy investments, but the focus of this summary will be the Carried Interest Changes.

Carried Interest Changes

The Tax Cut and Jobs Act passed in 2017 added new Section 1061 of the Internal Revenue Code of 1986, as amended (the “Code), which required carried interest recipients to hold their investments for three years in order to qualify for long-term capital gain tax treatment and be subject to a maximum tax rate of 23.8%. Gains that do not meet the three-year holding period are reclassified as short-term capital gain (taxable at ordinary income rates at a maximum tax rate of 37%). Section 1061 currently does not apply the three-year holding period to certain types of income that are taxed as capital gains under other provisions of the Code, including gains subject to Code Section 1231 (generally, gain from the sale of real property and depreciable personal property used in a trade or business and held for over one year) (“1231 gains) and qualified dividend income.

The Act would change the holding period necessary under Code Section 1061 to qualify for long-term capital gain tax treatment from three years to five years. Additionally, the Act would change the way the holding period is calculated, making it harder to achieve the five year minimum. Further, a carried interest recipient’s 1231 gains and qualified dividend income would now be subject to the five-year holding period in order to receive long-term capital gain treatment. The Act explicitly authorizes the Treasury to issue regulations or other guidance “to prevent the avoidance of the purposes of Section 1061, including through the distribution of property by a partnership and through carry waivers.”

The Act retains the three-year holding period for certain real estate trades or businesses and taxpayers with an adjusted gross income of less than $400,000. The Carried Interest Changes would apply to taxable years beginning after December 31, 2022.


Senate Majority Leader Schumer has promised to bring the Act to the Senate floor within the next week. If passed in its current form, the Act would significantly change the taxation of carried interest, limiting the preferential tax treatment received by many private equity firms and fund managers. At the time of this summary, Senator Krysten Sinema (D-Ariz.) has yet to announce her intention to support or oppose the Act, but Senator Sinema has stated in the past that she would oppose any bill with tax increases. Given the low probability of bipartisan support, Senator Sinema’s vote will likely determine whether the Act passes or stalls in the Senate.

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08.01.2022  |  PUBLICATION: GlobalNote  |  TOPICS: Investment Management, Tax

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