Refining Revenue Estimates for Taxing Carried Interest

Many policy experts have thought for some time that previous analysis has underestimated how much revenue could be gained from reforming how carried interest is taxed.1 New academic work and available Internal Revenue Service (IRS) data have allowed The Budget Lab to update its approach to scoring these proposals. The results indicate that previous estimates did, in fact, substantially undercount how much revenue could be gained from reforming carried interest taxation. For instance, a revenue estimate of Senator Wyden, Whitehouse, and King’s recent reform proposal using old methods raises $47.5 billion over 10 years. Using new methods, we instead estimate revenue of $87.7 billion over 10 years.

The “carried interest loophole” refers to a particular compensation arrangement in which fees paid to fund managers are not taxed as ordinary income. It is a performance-based compensation structure used in private equity and venture capital funds whereby fund managers receive a share of the profits generated by the fund's portfolio companies. In a typical arrangement, managers receive an annual management fee of 2% of invested capital plus a "carried interest" equal to approximately 20% of the fund's income. 

The specific design varies: venture capital firms usually provide a straight one-fifth share of all income, while buyout firms commonly require an 8% hurdle rate of return before managers receive any carried interest. This profit-sharing arrangement aligns the incentives of fund managers (general partners, or GPs) with those of their investors (limited partners, or LPs). What makes carried interest particularly noteworthy is its favorable tax treatment: the grant of a profits interest is not treated as a taxable event, tax is deferred until the partnership realizes gains by selling investments, and distributions are typically taxed at the long-term capital gains rate rather than at ordinary income rates. This stands in stark contrast to corporate executive compensation, where stock option gains are generally taxed as ordinary income. 

This tax treatment hinges on the allocation of profit to managers in excess of any contributed capital. Additionally, when fund income consists of qualified dividends or long-term capital gains, these are taxed at preferential rates rather than ordinary income rates.2

Over the last twenty years, there have been a number of proposals related to reforming the taxation of carried interest. From 2007 to 2010, Rep. Levin introduced bills that would tax carried interest at ordinary rates; these bills passed the House but either stalled in the Senate or had their carried interest provisions removed from final legislation.4 From 2010 to 2016, President Obama included a proposal to tax carried interest as ordinary income in each of his budget proposals. During this time, Rep. Levin introduced the Carried Interest Fairness Act in 2012, Rep. Camp introduced the Tax Reform Act (2014) that included a carried interest proposal, and Reps. Levin and Baldwin introduced the Carried Interest Fairness Act of 2015. 

In 2017, the Tax Cuts and Jobs Act was enacted into law. It included a provision that increased the holding period required for carried interest to qualify for the long-term capital gains rate from one to three years.5

From 2021 to 2024, the Biden administration proposed taxing carried interest as ordinary income for only those earning above $400,000 in income.6 During this period, carried interest proposals were included in a standalone bill (the Carried Interest Fairness Act) and as parts of larger bills (the Build Back Better Act and the Inflation Reduction Act), but no proposal was enacted. 

In February 2025, Reps. Beyer and Gluesenkamp Perez introduced the Carried Interest Fairness Act of 2025, with Sen. Baldwin introducing an identical companion bill in the Senate. 

Proposals have included full recharacterization of carried interest income as ordinary income and/or extending the holding period required to receive preferential rates. The revenue estimates have remained relatively consistent in recent years, ranging from $10 billion to $20 billion over ten years (depending on whether certain industries were carved out). However, recent research suggests that these estimates understate the potential revenue from a broad recharacterization of carried interest as ordinary income. 

Any revenue estimate faces methodological and empirical challenges that introduce uncertainty into the final estimate. Estimating the budgetary effects of tax legislation requires forecasting taxpayer responses to policy changes, including potential modifications to labor supply, savings decisions, business organizational form, and the timing of economic transactions. These behavioral adjustments are particularly difficult to predict for truly novel policy proposals. Revenue estimates may also rely on macroeconomic assumptions for income growth, inflation, interest rates, or employment levels, each of which is subject to considerable forecast error over multi-year budget windows. Data limitations further complicate the estimation process, as information on taxpayer characteristics, income sources, and deduction patterns may be incomplete or outdated. All of the carried-interest revenue estimates were subject to these limitations. A particular issue with carried interest is that there does not exist an item on any tax form that identifies income as "carried interest." In fact, the only reported amount of carried interest is on a prospectus filed by a publicly traded partnership.

Given the lack of data, estimators are required to infer the amount of carried interest and behaviors associated with the change in its taxation. This can be done indirectly using the reported carried interest for some publicly traded partnerships. Extrapolating to other publicly traded partnerships and similar private partnerships, when deemed sufficiently similar, allows for a more comprehensive assessment of carried interest.   

This carried interest income can then be adjusted for time lags, since carried interest in one year could represent compensation from previous years and may look different under the new taxation. These timing adjustments can be informed by information from publicly announced deals, among other information.

As partnerships have grown in importance over the last twenty years, estimators have used IRS administrative data to refine the estimates involving partnerships. However, data limitations have continued to hinder the process. 

Recently, some limitations have been overcome with greater use of electronic filing by partnerships. In a 2015 Treasury working paper, researchers traced income from partnerships to individuals and corporations.7 The authors were limited to the items on the K-1 partnership information return, which contains items like a partners’ capital and profit account. However, the IRS did not pick up items that would allow an identification of amounts attributable to carried interest. 

As noted in Love (2025), information on partners’ capital and profit accounts does make it possible to track profit allocations in excess of contributed capital.8 This newly available information improves the approximations and aggregates used in the revenue estimation described above and allows a greater understanding of carried interest, potentially changing the revenue associated with proposals that tax carried interest as ordinary income. For government estimators (and those with access to the administrative data), this data allows for a detailed accounting of capital contributions, profit shares, and allocations (income and deductions) by each partner. 

Essentially, estimates of carried interest can exploit the fact that carried interest represents a share of profits interest not supported by capital contribution. As noted in Love (2025), this amount is likely to be a lower bound on total carried interest. It is possible that profits were not distributed and as such, the partner’s capital share increases even though no capital was contributed.9

Consider the following stylized calculation. Suppose that a partner has a 20% share of profits according to the K-1 but only 15% of the capital; the partner then has a 5% carried interest.10 The upper-bound calculation accounts for the fact that many general partners are in fact another partnership, treating any allocation to a general partner that is a partnership as being entirely attributable to carried interest. This amount is an upper bound because it is possible that the general partner has contributed capital. 

Love’s methodology allows a more robust estimate of carried interest, including behavioral effects on the range of the carried interest base. It also allows the estimators to determine from tax returns the extent to which the upper or lower bound applies given a particular proposal. Love reports that between 2011 and 2020, a reasonable estimate of total carried interest grew from approximately $35 billion to $89 billion.

Table 1 presents the revenue that would be raised under three proposal options. For both the Biden 2025 President’s Budget proposal and the Wyden et al. “Ending Carried Interest Loophole,” we present the revenue raised under the old methodology and the new methodology. For the third proposal, we only present the new methodology.11

The third proposal can be seen as the broadest carried-interest proposal. It neither limits the change in taxation by income level nor industry, and it includes any compensation that is contained in Section 1231 gains.12 The three options for this proposal include portions of 1231 gains that are attributable to carried interest. We currently do not have the capability to identify the portion that is carried interest and so show  these amounts for illustrative purposes. Government revenue estimators and those with access to administrative data would be able to parse the amounts more carefully. Ultimately, the new methodology sheds light on the considerable amount of carried interest and the considerable revenue that could be raised with a broad proposal to tax all carried interest at ordinary rates. 

As noted above, carried interest is not claimed on a specific line of Form 1040. It is simply a share of partnership income allocated to a fund manager under the terms of a partnership agreement. There is nothing in the current tax code that requires the partnership to identify which portion of an allocation to a general partner or managing member represents a profits interest earned as compensation rather than a return on invested capital. The result is that the tax base for any reform of carried interest taxation has to be constructed indirectly from data that was never designed to measure it.

Love (2025) attempts to solve this problem by using the Schedule K-1 and 1065 filings to isolate the portion of their income allocations that reflects a carried interest rather than a capital contribution.  Estimated carried interest amounts depends on assumptions about typical fund structures, general partner (GP) co-investment rates, and the relationship between a partner's capital account balance and their economic contribution. The recent development in Love (2025) highlights how sensitive revenue estimates are to these assumptions. Depending on how one treats the GP's own capital contribution, the fund-of-funds structures, and the timing of gain recognition across a fund's life, the estimated tax base for carried interest can vary substantially. This is not a failure of methodology so much as a reflection of the underlying data gap, which could be addressed with additional information reporting. 

If the partnership were required to separately identify, on the Schedule K-1 issued to each general partner or managing member, the portion of any income allocation attributable to a profits interest held in lieu of a management fee or performance fee, revenue estimators would have a direct measure of the base. The Joint Committee on Taxation, Treasury's Office of Tax Analysis, and outside researchers would no longer need to impute carried interest amounts. This additional information would allow more precise revenue estimates and allow for a true assessment of the value of any change to the taxation of carried interest. Furthermore, the additional reporting would likely lead to an increase in compliance, and thus possibly more revenue.