Tax Policy Stability Fuels Private Equity Valuations: Act Now Before the Loophole Closes

The U.S. private equity industry has long thrived under a tax system that treats carried interest—a manager's share of fund profits—as long-term capital gains, taxed at a maximum rate of 23.8%. Recent legislative inaction has frozen this advantageous framework in place, while looming proposals to close the so-called “carried interest loophole” add urgency to capital allocation decisions. For investors seeking outsized returns, this is a pivotal moment to capitalize on the status quo before potential regulatory shifts erode profit margins.

The Current Tax Advantage: A Private Equity Tailwind

The One Big Beautiful Bill Act (BBB), passed by the U.S. House in May 2025, explicitly excludes changes to carried interest taxation. This maintains the current system, which allows general partners (GPs) to pay 23.8% on carried interest after a three-year holding period—a stark contrast to the 40.8% top ordinary income rate. This disparity creates a tax arbitrage opportunity for GPs, boosting fund returns by up to 2-4% annually, depending on the fund's structure and jurisdiction.

The stability of this regime is a key driver of private equity valuations. Funds can reinvest post-tax profits more aggressively, while limited partners (LPs) benefit from higher distributable earnings. For example, a $1 billion fund with a 2% management fee and 20% carried interest retains $160 million more in net returns under the current tax rules than under a hypothetical ordinary income regime. This capital amplifies deal-making power, enabling GPs to outbid public markets and drive asset appreciation.

Regulatory Uncertainty: The Sword of Damocles

While the BBB sidestepped carried interest reform, the Carried Interest Fairness Act of 2025 (S. 445) looms in the Senate. If passed, it would reclassify carried interest as ordinary income, eliminating the tax advantage. The bill's provisions—including mandatory valuation liquidation assumptions and anti-abuse rules targeting partnership structures—would force GPs to pay an additional 17% in taxes, directly reducing returns to LPs.

Even the threat of reform creates uncertainty. In 2024, Blackstone's stock fell 12% after leaked Senate drafts suggested carried interest changes. Today's bipartisan stalemate offers a brief window of stability, but investors must act swiftly before legislative momentum shifts.

Valuation Implications: The Math of Tax Policy

The tax regime directly shapes private equity valuations through three channels:
1. Net Returns: Lower taxes boost distributable cash flow, allowing GPs to compound gains faster.
2. Discount Rates: Stable tax rules reduce risk perception, lowering required returns for LPs and raising asset valuations.
3. Competitive Advantage: Funds with tax-efficient structures can bid higher than rivals, inflating asset prices in their favor.

Consider a real estate fund targeting a 15% IRR. Under current rules, the GP's post-tax returns allow the fund to price assets at 90% of replacement cost. If carried interest becomes ordinary income, the same fund might only justify paying 82% of replacement cost, shrinking valuations by ~8%.

The Investment Case: Act Now, Before the Window Closes

The regulatory outlook is a race between two forces:
- Republicans: Prioritize maintaining the status quo to avoid alienating their financial sector base.
- Democrats: Push reforms to close loopholes, but lack the votes to pass S. 445 without bipartisan support.

For investors, this creates a golden opportunity:
1. Deploy Capital Now: Lock in current tax terms by committing to funds with multi-year holding periods.
2. Target Tax-Engineered Funds: Focus on managers adept at structuring deals to maximize post-tax returns (e.g., real estate, infrastructure).
3. Hedge Against Uncertainty: Allocate to secondary markets or hybrid vehicles that can adapt to regulatory changes.

The clock is ticking. If carried interest reform passes in the next 12–18 months, the industry's valuation framework will reset—and LPs who moved first will have secured the highest returns.

Final Call to Action

The carried interest debate isn't just about taxes—it's a defining moment for private equity's future. With legislative uncertainty on the horizon, now is the time to act. Investors who commit to private equity today will secure the benefits of a proven tax regime, while positioning themselves to weather any storm that follows. Don't let this window close without you.

Act now. The next decade's winners are being decided today.