David Weisbach, Walter J. Blum Professor of Law and Kearney Director of the Program in Law and Economics, recently posted this paper to SSRN. The abstract is below.
The Taxation of Carried Interests in Private Equity
DAVID A. WEISBACH
University of Chicago Law School
Virginia Law Review, 2007
U of Chicago Law & Economics, Olin Working Paper No. 365
This essay analyzes the tax treatment of carried interests in private equity. It argues that there are two competing analogies: service income and investment income. Standard approaches are not able to resolve which of the competing analogies is better and often fail even to recognize that there are competing analogies. The best method for determining the proper treatment of carried interests is through direct examination of the effects of each of the possible treatments, known as the theory of line drawing in the tax law. From this approach, it is clear that the better treatment of holders of carried interests is as investors. Key pieces of evidence include the longstanding policy premises behind partnership taxation and the complexity and avoidance problems with attempts to tax carried interests as service income.