Skip to content
Home Link Logo
US Insights

US Insights

Taxation of carried interest awards

US/UK taxation of carried interest awards

It is important to consider the tax impact across both sides of the pond when being awarded carry to avoid potential pitfalls.

Investment managers need to ensure correct elections are made, mitigate double-tax and ensure that the global tax position is optimised when the carry eventually pays out. To achieve this, collaboration with your tax advisor is essential.

Alex And Ross

Award of carried interest

Upon being awarded an interest in a carry vehicle, first an investment manager with US and/or UK tax exposure needs to consider certain preferential elections. These elections (Section 431 for UK tax and Section 83(b) for US tax), ensure that the carry is taxed at the preferential Capital Gains Tax rate and that it is not an extension of employment income (if an employee) or partnership income (if a partner). These elections have the effect of taxing the award at the unrestricted market value at the date of award. Given the nature of a typical right to carry, this may be relatively low. You should work with your employer to ensure the employee and employer treatments are consistent. It is worth noting that both elections have tight deadlines.

The Section 431 election (UK) is a joint election between the employer and employee and must be signed within 14 days of the award of the carry. It does not need to be submitted to HMRC but must be kept on file. Partners may wish to protectively file a Section 431 election, particularly if they become a director of the fund in question further down the line which could subject them to employment rules.

The section 83(b) election (US) does not distinguish between partners and employees; therefore, it affects all investment managers who are US citizens, green card holders or resident aliens. This election has to be filed with the IRS within 30 days of being awarded the carry.

Being awarded carry part way through a fund’s life cycle rather than in its infancy (when it has minimal value) means that upon the filing of the aforementioned elections there may be an income inclusion (at ordinary tax rates i.e., 45% UK rate which can offset the 37% US tax rate) on the difference between the fair market value and the price paid at the date of the award.

How to mitigate double tax on carry?

As mentioned in the previous article, carry is taxed on an ‘accruals’ basis in the US versus a ‘receipts’ basis in the UK. If you are a US taxpayer residing in the UK, the most efficient and prudent way to negate double tax is to make advance tax payments to HM Revenue & Customs (HMRC) on an annual basis, by 31 December. This allows UK tax to be claimed as a foreign tax credit on the corresponding US return. The carry, which is taxed as it accrues and reported annually on a Schedule K-1, will be sourced foreign so that the income and credits align. Note that this applies for regular US tax, not the 3.8% Net Investment Income Tax (NIIT), which cannot be offset by foreign tax credits.

This planning is particularly useful for US taxpayers who claim foreign tax credits on the ‘paid’ basis (which is the majority), whereby foreign tax credits are included on the US return in the year in which the foreign tax is physically paid irrespective of when it is due.

A fund’s Limited Partnership Agreement typically includes a clause which allows annual tax advances to be made to cover the US tax charges, even though the carry is not due to be paid out.  Should the hurdle rate be met, and the carry is eventually paid, it will be reduced to account for the early distributions covering the dry tax.

From a UK tax perspective, when the carry finally pays out, the bulk of the UK tax will already be covered by the credit sitting in the online account with HMRC. These are the cumulative payments made on an annual basis to frank the regular US tax payable in respect of the carry allocable to the taxpayer each year per the Schedule K-1 from the fund.

How we can help

Our US/UK High Net Worth team is fully versed in the US/UK tax considerations surrounding carried interest. As we can take care of your US and UK tax compliance and advisory needs all under one roof, we can ensure a joined-up approach to your Transatlantic tax affairs. We can assist in mitigating double tax, pro-actively plan ahead for receiving carry distributions and therefore ease any potential cashflow issues.

Please get in touch with your usual Blick Rothenberg contact or one of the team using the details on this page.

Personal tax is one of the most complex areas of wealth management and can significantly erode your wealth over time

Blick Rothenberg is considered to be market leaders in the taxation of non-UK domiciled individuals and offshore trusts, as well as cross-border personal taxation.

We have a strong base of clients in the UK and a broad and longstanding international focus too, acting for a large number of non-UK domiciled individuals and international families. So, we understand the complexities that US citizens face when living, working and operating businesses in the UK.

Whether you are a start-up entrepreneur, a wealthy family with complex affairs, or a business executive, our dual-qualified team of tax advisers will look after your US UK personal tax affairs as well as those of your business.

If you wish us to contact you or want to discuss your situation please complete the form on this page and one of our team will be in touch.

Contact our team