Changes

Here, we must reconsider the structure of a private investment fund. General partners are compensated for managing their private investment funds through management fees and carried interest. Management fees are consistently around 2 percent of a fund's assets under management and are paid regardless of the fund's performance. Carried interest, alternatively, serves to join the incentives of the general partners with the interests of the limited partners by providing performance based compensation for the general partners. When a private equity or hedge fund surpasses its hurdle rate of return, usually about 8 percent, the general partners will typically receive around 20 percent of the profits as compensation. The general partner in a venture capital fund, on the other hand, will consistently receive 20 percent of the profits as long as the limited partners have received a return at least as much in return as equal to their contributed capital. This 20 percent, in combination with any other profit the general partner may receive from their own stake in the fund, is treated as a capital gain for tax purposes. The 2 percent management fee is treated as ordinary income for tax purposes. The maximum rate for a capital gains tax is 20 percent, compared to the maximum rate for an ordinary income tax of 39.6 percent.

Those who argue against treating investment funds' profits as capital gains have two primary points. The first of which is that carried interest is only taxed when it is realized. Through this tax deferral, the carried interest can benefit from the time value of money. Thus, the general partners at the private investment funds then have what some perceive to be unfair tax advantage. However, the tax deferral argument is particularly more relevant when it comes to funds that are not persistent with their returns. The second and more emphasized point is that carried interest is subject to the capital gains tax rate mentioned in the previous section. Opponents of such treatment consider carried interest to be a performance based compensation, much like a bonus, and accordingly believe it should be taxed at the ordinary income rate. In their argument, the opponents frequently compare general partners' roles to those of corporate executives and mutual fund managers who are subject to the ordinary income rate.

http://www.taxpolicycenter.org/briefing-book/what-carried-interest-and-how-should-it-be-taxedBasic carried interest description

http://www.ntanet.org/NTJ/61/3/ntj-v61n03p445-60-taxation-carried-interest-understanding.pdfIn depth descriptions of effects of carried interest and its treatment