H.R. 1091: Carried Interest Fairness Act of 2025

Here is how carried interest works. A private equity or hedge fund manager typically collects two forms of compensation: a management fee (usually 2% of assets) and a performance allocation (usually 20% of profits). The management fee is taxed as ordinary income at rates up to 37%. But the performance allocation — carried interest — gets taxed at the long-term capital gains rate of 20%, plus a 3.8% net investment income tax, for a top rate of 23.8%. That is a 13-percentage-point discount on what is functionally payment for services rendered.

The bill's mechanism is straightforward. It creates a new Section 710 of the Internal Revenue Code that recharacterizes all net capital gain from an "investment services partnership interest" as ordinary income. It also repeals Section 1061 — the three-year holding period rule that Trump's 2017 tax law added as a half-measure. Under current law, if a fund holds an asset for three years, the manager's carried interest on that asset qualifies for capital gains treatment. H.R. 1091 eliminates that distinction entirely.

The bill does not stop at income recharacterization. It strips carried interest of access to the qualified small business stock exclusion under Section 1202, blocks qualified dividend treatment on dividends allocated to carried interest, and subjects carried interest income to self-employment tax — which it currently escapes. That last piece matters more than it sounds: the 15.3% self-employment tax (Social Security and Medicare) is a cost that W-2 employees and self-employed workers cannot avoid, but carried interest holders have never paid it.

For managers who try to game the new rules, the penalty is doubled. The standard 20% accuracy-related penalty on underpayments jumps to 40% for transactions designed to avoid Section 710. The reasonable cause defense still exists but requires the taxpayer to prove adequate disclosure, substantial authority, and a more-likely-than-not belief that their treatment was correct — a significantly higher bar than the usual standard.

The bill carves out one important exception: qualified capital interests. If a fund manager contributes actual money or property to a fund — their own capital at risk, not a profit share received for services — the returns on that contribution are still taxed at capital gains rates. The bill only targets the "sweat equity" portion of carried interest, not genuine investment returns.

The Congressional Budget Office has estimated that taxing carried interest as ordinary income would raise approximately $12 billion over ten years. The bill's sponsors cite a figure of $6.5 billion over a decade, reflecting the narrower scope of this particular legislation. Either way, the loophole's survival in Trump's "One Big Beautiful Bill" — signed July 4, 2025 — despite the President's own stated support for closing it, underscores how durable this tax break has proven against legislative assault.