Abolishing the Carried Interest Tax Loophole May Induce Predatory Operations in Private Equity
The closure of the carried interest tax loophole has once again become a policy focus. Although this move helps alleviate fiscal deficits, the author warns that without the three-year holding period incentive, the private equity industry may slide toward short-termist practices such as rapid flipping and asset stripping, harming industry reputation and the investment ecosystem.
Editor's note: Kade Thomas is the founder and CEO of Emory Oak Partners, a private equity firm based in Austin, Texas. The views expressed in this article are solely those of the author.
The battle over the carried interest tax loophole has persisted for years, and with the Trump administrationsignaling its intention to close this tax break, the debate has heated up once again. While closing this loophole would undoubtedly help balance the fiscal budget, it could inadvertently encourage poor investment habits within the private equity industry.
For decades, the carried interest loophole has been a focal point of controversy. Both Republicans and Democrats have repeatedly mentioned repealing this tax break, but neither party has actually pushed the policy through.
Specifically, this loophole means that the carried interest profits that general partners (GPs) receive for managing investments are not taxed at the income tax rate of up to 37%, but rather at thelower capital gains tax rate of 20%, allowing GPs to retain more earnings.
To qualify for the preferential tax rate, the assets corresponding to the investment profits must be held for three years or more. Before 2017, the qualified holding period was only one year, but Trump, during his first term,extended it to three years, to encourage long-term investment. In my view, this was a positive measure, prompting private equity firms to better support and nurture their portfolio companies.
By lengthening the qualified holding period, firms are guided to adopt a long-term perspective, driving real, sustainable organic growth within their portfolio companies.
However, facing the practical pressures of budget deficits, the president naturally needs to find ways to cut costs wherever possible. President Trumpis pushing for trillions of dollars in tax cutsto stimulate consumption and boost the U.S. economy, so he is also actively seeking opportunities to recover government funds.
But I worry that eliminating the carried interest tax break could have an unexpected yet significant consequence. In fact, poor habits within the private equity industry are already quite common, even earning it a reputation for being "predatory." Of course, many GPs focus on long-term value when structuring their portfolio companies, but I know well that not all firms do so.
For some firms, acquiring companies is merely a means to make short-term profits. These firms may quickly flip businesses, lay off experienced employees, and strip assets to make a quick buck. Once the incentive to hold for three years is lost, these practices could become even more widespread across the industry.
If such approaches spread, the industry's reputation will inevitably deteriorate further. Private equity investment has the potential to enhance corporate value and provide a springboard for companies to achieve greater success, but if potential portfolio companies hold the opposite perception, they may become more resistant to accepting investment.
We know that poor practices have already left their mark on the business ecosystem—the number of private equity-backed bankruptcies hit a record high in 2024. Now, companies may not only be more vulnerable to harmful private equity operations, but may also face the impact of a decline in private equity deal volume.
Althoughdeal activity is expected to increase in 2025, if the incentive to take risks in investing in American businesses is inadvertently weakened, the volume of private equity-led M&A deals could be suppressed. In short, closing this loophole could bring unintended consequences that cannot be ignored.
The fact is that a sudden jump in the tax rate from 20% to as high as 37% could completely upend the overall strategy of how GPs manage their portfolio companies. In the worst-case scenario, in order to quickly boost internal rates of return (IRR), we might see some firms resort once again to short-term flipping and harmful tactics—practices that should have no place in our industry.
I urge policymakers to take a deep and nuanced look at the potential implications lurking behind any proposal to repeal the carried interest loophole. Closing it could send a dangerous signal to the private equity industry.