Carried interest reform returns to Congress: Ending the Carried Interest Loophole Act

On April 16, 2026, Senators Ron Wyden (D-OR), Sheldon Whitehouse (D-RI), and Angus S. King Jr. (I-ME) introduced the Ending the Carried Interest Loophole Act (Bill). If enacted into law, the Bill would impact fund sponsors, investment managers, their employees, and other carried interest holders.

The Bill only reflects proposed legislation, and current law has not changed. As introduced, the Bill does not include Republican sponsors.

Background on carried interest reform

Carried interest has long been a focus of tax reform proposals. Carried interest is a share of the profits of a partnership based on the performance of the partnership’s underlying investment. Carried interest recipients often perform investment management activities for partnerships and are common in the investment funds industry.

Allocations of profits associated with carried interest are often taxed at favorable long-term capital gains rates. Opponents of the current tax treatment of carried interest argue that the recipients (carried interest holders) are converting higher-taxed ordinary income from the performance of services into more favorable long-term capital gains allocated by the partnership. Further, given that a profits interest often does not have any value on the date of grant, carried interest holders are not subject to tax on the receipt of the carry.

Section 1061 of the Internal Revenue Code (the Code) addresses the concerns that carried interest converts ordinary income to long-term capital gains by extending the holding period for long-term capital gains rates from one to three years.

Since 2021, proposals for additional tax reform have taken two broad approaches:

1. Some proposals further extended the Section 1061 holding period to five or more years
   
   
2. Others aimed to tax capital gains allocated to carried interest holders as ordinary income, thus eliminating long-term capital gains tax treatment altogether

How does the new proposal affect carried interest holders?

Unlike both current law and prior proposals that either extend the requisite long-term capital gains holding period or eliminate capital gains altogether with respect to carried interest, the Bill introduces a new deemed income recognition concept for carried interest holders.

If enacted, the Bill would repeal Section 1061 and replace it with a new Section 1299, which creates a deemed-compensation framework resulting in annual phantom income for carried interest holders. Thus, a carried interest holder would be deemed to receive annual compensation from the partnership regardless of whether the partnership generated any income or made distributions in such year.

Key features of the Bill include:

• Annual ordinary income recognition. Carried interest holders would include an amount in income each year as deemed compensation, subject to tax at ordinary income rates and self-employment tax.
  
  
• Matching capital loss. A corresponding deemed long-term capital loss is granted to the carried interest holder, equal to the deemed compensation income, to offset capital gains that will be recognized when the carried interest actually produces long-term capital gain. The intent is to cause the carried interest holder to be taxed earlier, and at ordinary rates, and only taxed in the future at long-term capital gains rates to the extent future capital gains exceed the earlier deemed compensation income.
  
  
• Broad coverage. Section 1299 applies to “applicable partnership interests,” which largely follows the definition of applicable partnership interests under Section 1061. To address the potential for abuse, the rules also apply to certain contracts or instruments that derive their value from partnership distributions, assets, or operating results.
  
  
• Deemed compensation determination. The deemed income computation aims to replicate an annual return on the portion of invested capital that was 1) contributed by the limited partners (excluding any capital contributed by the carried interest holders), and 2) allocated to the carried interest holder. For example, if the limited partners contributed all of the capital and the carried interest holders are entitled to receive 20 percent of the residual partnership profits, the computation would apply to 20 percent of the invested capital. Deemed income is determined by multiplying the relevant invested capital base by a rate that equals the five-year high-quality market corporate bond yield (reflecting lower-risk investments) plus a fixed spread of 9 percent to approximate the yields of higher-risk investments.
  
  
• Accelerated disposition inclusion. Sales of applicable partnership interests may accelerate up to ten years of future deemed compensation into the year of sale.
  
  
• Section 83 revisions. The Bill would also amend the applicability of Section 83 to grants of carried interest, making the current elective Section 83(b) framework the default rule. Grants of profits interests would continue to be untaxed so long as there is no immediate value to the profits interest (i.e., if the partnership were to sell all of its assets and liquidate at the time of transfer, no value would be given to the interest). Revenue Procedures 93-27 and 2001-43, which guide the tax treatment of certain profits interests on grant, would no longer apply to the extent that they address applicable partnership interests.

Implications

The proposed overhaul of carried interest taxation, as proposed in the Bill, may encourage sponsors and investors to reassess whether carried interest, in its current form, is the most effective method for compensating fund managers.

Key takeaways for sponsors

Although the Bill has not been enacted, it should be monitored closely as it could serve as the groundwork for future legislation. While there is ongoing interest in carried interest reform, reaching agreement on the specifics has been challenging. For example, President Donald Trump’s congressional tax meeting in February 2025 included a call to end preferential taxation of carried interest. However, the meeting did not lead to legislative action.

It remains to be seen whether the 2026 midterm elections will affect the next phase of carried interest reform.

Learn more

To learn more, please contact any member of DLA Piper's Investment Funds practice group.