S. 4330 — Ending the Carried Interest Loophole Act

This section modifies the rules under Section 83 for partnership interests transferred in connection with the performance of services (i.e., typically profits interests granted to service providers, which under prior law often had zero value at grant under safe harbor guidance). It requires valuation of such an interest at the amount the recipient would receive if the partnership sold all assets for fair market value in a fully taxable transaction and distributed net proceeds (after liabilities) in complete liquidation; treats the recipient as having made the Section 83(b) election to include that amount in gross income in the year of transfer unless the recipient elects out under similar rules; and treats the included amount as an addition to the recipient's capital account under subchapter K and, if an applicable partnership interest under Section 1299, as invested capital. (Thus, it generally accelerates income recognition at transfer and resets the holding period for carried interest purposes under Section 1299.) The rules also apply to applicable financial instruments or non-partnership interests treated as partnership interests under Section 1299(b)(2), with regulatory authority provided to the Secretary, and take effect for transfers after enactment.

This section establishes new IRC §1299 to tax certain partnership interests received in connection with services in investment activities (commonly known as carried interests). For a taxpayer holding one or more applicable partnership interests during a partnership taxable year, the provision requires inclusion in gross income of the aggregate deemed compensation amounts as ordinary income and treats the taxpayer as having a long-term capital loss equal to such amounts. An applicable partnership interest generally includes any partnership interest (including certain financial instruments) transferred or held in connection with services performed in an applicable trade or business—defined as a regular, continuous, and substantial activity of raising or returning capital and investing in, acquiring/disposing of, or developing specified assets (i.e., securities, commodities, investment real estate, cash equivalents, derivatives thereon, or related partnership interests)—or any interest acquired using an applicable loan from the partnership or related persons (except fully recourse loans secured by borrower assets bearing interest at least at the specified rate). (Thus, service providers in private equity, hedge funds, and similar investment partnerships must recognize ordinary income on a portion of the partnership's invested capital, offset by a capital loss.) The deemed compensation amount for an applicable partnership interest equals the product of (1) the specified rate for the calendar year and (2) the excess of an applicable percentage of the weighted average aggregate invested capital of all partners (measured on specified dates including the partnership year-end) over the weighted average invested capital attributable to the applicable interest.