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94 Va. L. Rev. 715 (2008)
The Taxation of Carried Interests in Private Equity

handle is hein.journals/valr94 and id is 721 raw text is: ESSAY THE TAXATION OF CARRIED INTERESTS IN PRIVATE EQUITY David A. Weisbach* T HIS 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 re- solve which of the competing analogies is better and often fail even to recognize that there are competing analogies. The best method for de- termining the proper treatment of carried interests is through direct ex- amination of the effects of each of the possible treatments, known as the theory of line drawing in the tax law. Using 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. In particular, the longstanding policy behind partnership taxation is to tax partners as if they engaged in partnership activity directly. Current law, which gives holders of carried interests capital gains treatment follows this ap- proach, and changing the law to tax carried interests as service income would require rejection of this historical trend. Because such an ap- proach would mean taxing carried interests differently than if the part- ners engaged in the activity directly, it would be easily avoidable. More- over, attempts to tax carried interests as service income will have to be able to distinguish service income from other types of income, a task which has proven to be difficult and complex. 715 . Walter J. Blum Professor and Kearney Director, Program in Law and Economics, The University of Chicago Law School. This research originated with work funded by the Private Equity Council, published at 116 Tax Notes 505 (August 6, 2007).

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