HOW ‘CARRIED INTEREST’ TAX BREAK WORKS

“It [carried interest]came into its modern usage in the nineteen-twenties, in the oil-and-gas industry, and was enshrined in the federal tax code in 1954. When a group of partners drilled for oil, a few would put up the money and others would invest only their labor, or ‘sweat equity’— finding land and investors, buying equipment, and so on. If the partners sold out, the I.R.S. would tax the profits of all the partners at the lower rate for capital gains rather than as ordinary income.

“Over time, partnerships in other industries, mainly real estate and venture capital, began taking advantage of the same form of taxation. Private-equity firms stretched the model to its breaking point. Their work is essentially a combination of investment banking and management consulting: they are compensated not for building new ventures from scratch, with the risk that entails, but for managing the investments of wealthy individuals and pension funds and other institutional clients. These funds are pooled, along with borrowed money, to acquire private companies or to take public companies private—before making improvements or cutting costs and selling at a big profit.”

Alec MacGillis, “The Billionaires’ Loophole,” New Yorker, March 14, 2016, pp: 64-73.