Income classification with respect to private investment funds has been subject to heavy scrutiny over the past few years, as critics have attacked the management structures and compensation practices of fund managers. At the foundation of the debate lies the disparate characterization of income as either “ordinary income” or “capital gains income,” and the preferential tax rates afforded to capital gains income. In the context of private investment funds, fund managers are generally compensated with a “two and twenty” pay structure. The “two” refers to a small percentage of fund managers’ compensation, which is treated as a management fee and taxed as ordinary income. The major point of contention rests with the “twenty” portion of the pay structure, where fund managers are compensated with a 20% profits interest. It is this profits interest that has been given the term-of-art colloquially known as “carried interest.” Although proponents of carried interest have not gone so far as to label carried interest as a “tax shelter,” reformists point to the inequities of the status quo as a basis for legislative action. View More