Buyout funds acquire ownership stakes in businesses of all sizes. In short, private equity and hedge funds, once marginal players, now exert what could be characterized as significant influence in the markets where they operate. Fund Structure and Compensation

While private equity firms and hedge funds may differ in their investment strategies, their structures are similar. There are two kinds of partners. The fund managers, who guide the investment strategy, are general partners. The general partners often invest their own capital in the funds, but this is usually a small share of the total managed by the fund. Small public investors are generally not able to invest in hedge funds, because they lack either the assets or income. The 20% performance fee is sometimes paid in cash, and sometimes credited to the manager's account. Tax Issues and Proposals

Congressional proposals have evolved since the 110 th Congress from the full taxation of carried interest as ordinary income to more nuanced approaches that account for "enterprise value" and tax carried interest at some blend of the capital gains and ordinary income tax rates. In the 113 th Congress, S. 268 and the President's FY2014 Budget Proposal take a nuanced approach that treats carried interest as a mix of capital gains and ordinary income. The Tax Reform Act of 2014 would exempt carried interests derived from real estate but tax a portion of the remainder as ordinary income. According to the Joint Committee on Taxation, the provision in the Tax Reform Act of 2014 would raise $3.1 billion in revenue in the FY2014-FY2023 budget window, while the provision in the President's FY2014 Budget Proposal would raise $17.4 billion in revenue in the FY2014-FY2023 budget window. Tax Treatment of Publicly Traded Partnerships

Instead of changing the tax treatment of fund managers' income, another approach would change the tax treatment of some hedge funds that are organized as publicly traded partnerships.
Private equity and hedge funds are investment pools generally available only to institutions and individuals able to make investments in excess of $200,000. Private equity funds acquire ownership stakes in other companies and seek to profit by improving operating results or through financial restructuring. Hedge funds follow many strategies, investing in any market where managers see profit opportunities. The two kinds of funds are generally structured as partnerships: the fund managers act as general partners, while the outside investors are limited partners. Fund managers are compensated in two ways. First, to the extent that they invest their own capital in the funds, they share in the appreciation of fund assets. Second, they charge the outside investors two kinds of annual fees: a percentage of total fund assets, and a percentage of the fund's earnings. The latter performance fee is called "carried interest" and is treated as capital gains under current tax rules.
Since the 110th Congress, concerns have been raised that the current tax rules are inequitable and inconsistent with some tax policy principles. Proposals that address this concern have focused on taxing some portion (or all in some cases) of carried interest as ordinary income. In the 113th Congress, the Tax Reform Act of 2014 would tax carried interest, exempting income earned from real estate, as ordinary income. S. 268 and the President's FY2014 Budget Proposal would tax carried interest as ordinary income, while taxing another form of compensation, known as enterprise value, as capital gains income. According to the Joint Committee on Taxation, the provision in the Tax Reform Act of 2014 would raise $3.1 billion in revenue in the FY2014-FY2023 budget window, while the provision in the President's FY2014 Budget Proposal would raise $17.4 billion in revenue in the FY2014-FY2023 budget window.
This report discusses the major issues surrounding the tax treatment of hedge fund and private equity managers and will be updated as legislative developments warrant.