Policymakers have been engaged in a push and pull over the carried interest tax loophole for years, and now the Trump administration has signaled the closure of the tax break, the debate appears to be reignited. Yet, while the closure will undoubtedly prove a useful way to balance the books, the move could unintentionally introduce damaging investment habits across private equity.

The loophole has been a controversial source of debate for decades. At one point or another, both Republicans and Democrats have talked about erasing the carried interest tax break, but neither party has ever pushed the policy across the finish line.

For context, the loophole means that any investment profits carried over to the general partner as compensation for managing the investment are not subject to income tax, which can be up to 37%. Instead, the lower capital gains tax rate of 20% is levied on these profits, leaving the general partner better off.

For investment profits to qualify for the reduced rate, firms must have held the assets for three years or more. Before 2017, the eligible holding period was as little as one year, but Trump extended it to three during his first term, encouraging a long-term approach to investing. For me, this was a positive move that incentivized private equity firms to support and nurture their portfolio companies.

By stretching out the eligible holding period, firms were encouraged to take a long-term view and drive genuine, sustainable organic growth across the businesses they plowed cash into.

Now, though, as the reality of the budget deficit sets in, the President understandably needs to find savings wherever possible. President Trump is pushing through trillions of dollars in tax cuts which could jumpstart consumer spending and bolster the US economy, and so is naturally looking for opportunities to recoup government money.

But I worry that there could be an unintended but important consequence to eliminating carried interest. The truth is that bad habits are already far too common across the private equity sector, so much so that it has developed a predatory reputation. Of course, many general partners build portfolio companies in a way that stands the test of time, but I’m all too aware that this is not the case for every firm.

For some, acquiring businesses is nothing more than a short-term money-making exercise.These firms can look to flip businesses quickly, gutting them of their experienced workforces and asset-stripping to make a quick buck. These practices could become increasingly prevalent across the industry without the incentive to keep businesses for more than three years.

With these methods taking hold, the sector’s reputation would inevitably sour further. Private equity investment has the potential to elevate businesses and provide a stepping stone to the next level of success, but if potential portfolio companies understand the opposite to be true, they could become more resistant to backing.

We know unsavory practices are already leaving their mark on the business ecosystem, with a record number of PE-backed bankruptcies filed in 2024. Now, not only could businesses be more susceptible to damaging private equity practices, but they could also find themselves suffering from a drop in PE dealmaking.

Dealmaking activity is expected to increase in 2025, but accidentally stripping away the incentive to take on more risk when investing in US businesses could damp private equity-led M&A volume. All in all, closing off this loophole could have unintended consequences that cannot be ignored.

The fact is that a sudden tax jump from 20% to up to 37% could unintentionally turn GPs’ entire approach to managing portfolio companies upside down. At worst, in an attempt to quickly increase their IRRs, we could see firms fall back on short-term selling practices and detrimental methods that should have no place across our sector.

I would urge policymakers to take a long and detailed look at the potential ramifications lurking beneath the surface of any proposal to eliminate the carried interest loophole. Closing it could signal danger for the private equity sector.