Carried Interest

November 23, 20152 min read
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The term carried interest refers to the amount of carried interest a fund manager or hedge fund manager receives on the overall performance of an investment.

Regardless of whether or not they have contributed to the initial investment – carried interest acts as compensation for a fund manager to help motivate them to ensure constant enhancement of selected funds.

Key takeaways:

  • Carried interest can be regarded as basic compensation for fund managers as motivation to ensure investment performance.
  • Some investors also see carried interest as capital gains on investments carried over to be reinvested.
    Currently, fund managers are taxed 20% on all capital gains received through carried interest.
    How is carried interest calculated?
  • Depending on the original agreement set up between investors and managers, carried interest is typically between 20-25% of a fund’s annual profit. Some fund managers will agree upon a set percentage, while others will require both a fee and shared profit of the fund’s overall performance.

Is carried interest taxed?

All fund managers are subject to a 20% tax rate on the returns they generate from initial profits from investors. Although the investor is subject to different taxation i.e. capital-gains tax, or perhaps income tax, which is set at 37% in the United States, fund managers still pay a lot less than ordinary income taxpayers.

When is carried interest paid?

Every investor or fund manager will set certain targets for their initial investments. A real-world example will constitute that investments will first need to reach a minimum of 7-8% return on investment before carried interest can be paid out to the fund manager.

This is dependent on each scenario, as various fund managers will set up an agreement that meets both their needs and that of the investor.