What Is a Carried Interest?

What Is a Carried Interest?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Carried interest is a share of any profits that the general partners of private equity and hedge funds receive as compensation, regardless of whether they contributed any initial funds. This method of compensation seeks to motivate the general partner (fund manager) to work towards improving the fund’s performance.

Related Questions

1. How is carried interest calculated?

Carried interest is usually calculated as a percentage of the fund’s profits. The common industry standard stands at 20%, but it can fluctuate depending on the agreement between the fund managers and investors.

2. Is carried interest taxed?

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Yes, carried interest is taxed, but it is often taxed at a lower rate. This is because it’s generally considered a long-term capital gain, and thus, subject to a lower tax rate as compared to ordinary income.

3. Are there controversies surrounding carried interest?

Yes, there are controversies. The primary controversy revolves around the tax treatment of carried interest, particularly in the United States. Critics argue that since it is a form of compensation for services provided by the fund managers, it should be taxed as ordinary income and not as a capital gain.

4. Who usually receives carried interest?

Carried interest is generally earned by the general partners of private equity and hedge funds. These are usually the fund managers who make investment decisions and manage the operations of the fund.

5. Can carried interest be negative?

No, carried interest can’t be negative. This is because it’s a share of the profits. If the fund does not register any profits, the fund managers do not earn any carried interest. However, they may lose their carried interest in the future if the fund suffers losses.