Carried Interest Tax Reform Act

Summary#

S. 445, the Carried Interest Fairness Act of 2025, would amend the Internal Revenue Code of 1986 and the Social Security Act. Its stated goal is to change the tax treatment of personal-service income earned through pass-through entities; that is a goal, not a guaranteed result. The bill is still before the Senate Finance Committee and is not law.

  • For certain partnership interests received for services, the bill would generally treat the recipient as having elected to include the interest’s value in income when it is transferred. The value would be based on what the recipient would get if the partnership sold its assets and liquidated; the recipient could elect out of this rule.
  • It would generally treat investment gains allocated to covered service-related partnership interests as ordinary income, rather than capital gain. Some losses could be treated as ordinary losses, but only up to specified prior recharacterized gains.
  • It would also generally treat gains from selling those interests, and certain gains when partnership property is distributed, as ordinary income. It sets exceptions, including for certain qualified capital interests and transfers by gift or at death.
  • The rules would cover specified investment services and investment partnerships. They would also reach some other interests whose value is substantially tied to investment gains, with exceptions including for many domestic C corporations.
  • The bill would repeal Internal Revenue Code section 1061, add covered income and losses to certain self-employment calculations, and change rules for publicly traded partnerships. The publicly traded partnership change has a 10-year delay.

What it means for you#

  • Investment managers and other service providers: If your partnership interest and services meet the bill’s definitions, some gains could be taxed as ordinary income. The bill also limits when losses receive ordinary-loss treatment.
  • Partners who invest their own capital: Certain qualified capital interests could be exempt from the main recharacterization rule, but only if allocation conditions are met. For example, allocations generally must be made in the same manner as to significant interests held by partners who do not provide services and are not related to the service provider.
  • Individuals providing covered services: The bill would include specified investment-services income or losses in calculations of net earnings from self-employment.
  • Investment partnerships and entities: They could face new reporting and recordkeeping rules set by the Treasury Secretary. The bill does not itself set a full reporting process or deadlines.
  • Other taxpayers: The bill does not directly change general income-tax rates or create a new benefit program.

Money#

No publicly available information on the bill’s estimated budget or revenue effects.

  • The bill could change tax owed by covered service providers and other affected entities, and could change self-employment tax calculations. No estimates are supplied.
  • It authorizes Treasury to set reporting and recordkeeping rules, but gives no estimate for compliance or government costs.
  • It provides for a 40% penalty on certain underpayments, but the text’s cross-references create uncertainty about which underpayments the higher penalty would cover.

What is unclear#

  • The bill uses terms such as “substantially all,” “significant,” and “substantially related” without defining them in the text. Treasury may issue rules, but those rules are not provided.
  • The bill does not spell out how partnerships and service providers would apply the rules in all cases, or how the rules would interact with other tax provisions.
  • The 40% penalty provision refers to a different Internal Revenue Code paragraph than the paragraph the bill adds for the relevant anti-avoidance rules. The intended scope is unclear from the bill text.
  • The current Internal Revenue Code and Social Security Act provisions being amended were not supplied, so I could not verify how the bill’s changes compare with current law in full.
  • The bill’s main rules would apply only if enacted, and some have different effective dates. Passage is uncertain.

Case for#

  • The bill appears intended to tax income tied to investment-management services as ordinary income, rather than give it capital-gain treatment because it is received through a partnership.
  • It preserves an exception for certain capital interests, which could distinguish returns on qualifying invested capital from returns tied to services.
  • The bill includes anti-avoidance rules and lets Treasury issue guidance. That could help address arrangements designed to avoid the new rules.

Case against#

  • The definitions cover a wide range of assets and activities, including advising, managing, acquiring, disposing of, and arranging financing for assets. The bill leaves important boundary terms to later rules.
  • The rules could make tax reporting and compliance more complex for service providers and partnerships, while the bill provides no cost estimate or complete process.
  • Some covered income would lose qualified-dividend treatment or the benefit of the qualified small business stock exclusion. That could affect taxpayers beyond the basic reclassification of capital gain.
  • The penalty cross-reference mismatch makes it harder to know when the proposed 40% penalty would apply.