What is carried interest? Tax, vesting, and administration for fund managers

For private markets and fund managers, performance-based compensation is becoming more complex. Evolving tax regimes and sophisticated vesting arrangements mean carried interest now needs closer attention, and tax treatment in particular varies by jurisdiction.

Carried interest rewards fund managers for delivering strong, long-term fund performance, aligning their interests with those of investors. How well it works depends on how it’s structured and tracked over the life of a fund.

Historically, firms have managed carried interest on manual spreadsheets, a process that hasn’t kept pace with increasingly complex fund structures. Regulatory change is compounding this: the UK's reclassification of carried interest as trading income from April 2026 is the most significant recent example, and similar processes are underway across EU jurisdictions.  As firms adopt more sophisticated waterfall distribution models, outdated administration leaves managers exposed to operational and compliance risk.

This article covers what fund managers need to know about carried interest: what it is, how carried interest works, tax treatment, vesting mechanics, and the systems that support accurate, audit-ready administration.
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What is carried interest?

Carried interest, or “carry”, is the performance-based share of a private fund’s investment profits allocated to general partners (GPs) or fund managers. Unlike management fees, carried interest is typically paid once limited partners (LPs) have received the return of their invested capital and the fund has exceeded a pre-agreed minimum rate of return, known as the hurdle rate (or, once met, the preferred return).

The standard compensation model across private markets fund structures is the “2 and 20” structure. GPs charge an annual management fee of around 2% of committed or managed capital to cover operating costs, and receive 20% of the fund’s profits as carried interest. Fee arrangements vary depending on market conditions and a manager’s track record, and carry above 20% is not unheard of at firms with strong track records, but the 80/20 profit split between LPs and GPs remains the industry standard.

Carried interest ties GP compensation directly to fund performance rather than to the size of the fund itself. If a fund underperforms and never clears its hurdle rate, the GP earns no carry no matter how much capital they’ve raised or deployed. That’s what distinguishes it from management fees, which are paid regardless of results, and it’s why carried interest is generally treated as the primary long-term incentive in fund manager compensation.
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How does carried interest work?

Carried interest is earned over the life of a private fund. GPs raise capital from LPs, invest it in portfolio investments, and typically hold those investments for several years. When investments are sold, proceeds are distributed in a predefined order set by the fund’s distribution waterfall.

The first milestone is the hurdle rate: a pre-agreed minimum annual return, typically around 8%, that the fund must clear before LPs receive their preferred return and the GP becomes eligible for carried interest.

Once LPs have received their capital back and their preferred return, the waterfall typically enters a catch-up phase. Here, the GP receives a larger share of profits, sometimes up to 100%, until they’ve caught up to their agreed percentage of total profits.

After the catch-up is complete, remaining profits are split according to the fund’s agreed ratio, most commonly 80% to LPs and 20% to the GP as carried interest. If a fund does not clear the hurdle rate, the waterfall stops at step one: LPs get their capital back, and the GP receives no carry at all.

The exact sequencing of these steps can vary by fund structure – whole-fund waterfalls apply this order across the fund as a whole, while deal-by-deal waterfalls can allow GP carry to be paid out earlier, on a per-investment basis, before the entire fund has returned capital.
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Distribution waterfall table

How is carried interest calculated?

Carried interest is calculated by applying the fund’s distribution waterfall to the profits generated when investments are realised. The example below is simplified for illustration and assumes the return is achieved in a way that clears the fund's IRR-based hurdle (in practice, a hurdle rate is an annualised return test, so the absolute profit needed to clear it depends on the fund's holding period).

Take a simplified £100 million fund with an 8% hurdle rate and 20% carried interest. If the fund exits all of its investments for £140 million, generating £40 million in profit, and this return is sufficient to clear the fund's 8% IRR hurdle over its holding period, the carried interest provisions are triggered.

Compare that to a fund that returns only £105 million. A £5 million profit is unlikely to clear an 8% IRR hurdle over a typical multi-year holding period, so the GP would receive no carried interest. Everything goes to the LPs.

Once the hurdle is cleared, the distribution waterfall determines how the £40 million profit is allocated between LPs and the GP. This example assumes the catch-up phase results in the GP receiving the standard 20% split with no separate catch-up allocation, for simplicity:
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Carried interest in private equity vs venture capital

Carried interest in private equity works differently than in venture capital, even though both use it as the core performance-based compensation mechanism for GPs. The two biggest differences are hurdle rates and distribution timing. Private equity funds often require a minimum return threshold before carried interest is paid, while many venture capital funds operate without one. Distribution models differ too: private equity funds often distribute carry as individual investments are realised, while venture capital funds more commonly calculate carry based on the performance of the fund as a whole.

In private equity, GPs typically receive 20% carried interest over a fund life of eight to 12 years. Most funds include a hurdle rate of around 8% that must be cleared before carry is distributed, and many use a deal-by-deal waterfall (sometimes called an "American" waterfall), paying carried interest out as individual investments are successfully exited.

Venture capital funds also commonly use a 20% carry structure, but many early-stage funds skip the hurdle rate entirely. Carry is typically realised only after major liquidity events, such as IPOs or company sales, so distributions happen later in the fund’s lifecycle.

These structural differences carry real risk implications. Deal-by-deal distributions in private equity can expose GPs to clawbacks if strong early exits are followed by weaker overall fund performance. Venture capital funds, by contrast, often use a whole-fund ("European") waterfall, requiring LPs to recover their invested capital across the entire fund before the GP receives any carried interest.

Carried interest tax in the UK and Europe

Carried interest tax treatment can vary by jurisdiction and depends on how carry is structured. It may be taxed as capital gains, employment income, or trading profits.

How carried interest is taxed in the UK

UK tax treatment of carried interest changed significantly from 6 April 2026. Following the Finance Act 2026 (which received Royal Assent on 18 March 2026), carried interest is generally subject to Income Tax rather than Capital Gains Tax (CGT) under the new rules. This followed a transitional period between April 2025 and April 2026, during which the CGT rate on carried interest increased to 32%.

Under the new rules, all carried interest is treated as trading profits and subject to Income Tax and Class 4 National Insurance Contributions. However, only carried interest that meets the "qualifying" test benefits from relief, and this depends on the fund's Average Holding Period (AHP), broadly requiring a weighted average investment holding period of 40 months or more for full relief, with partial relief between 36 and 40 months. Qualifying carry benefits from a 72.5% multiplier – meaning only 72.5% of the amount is subject to tax, which means the effective tax rate is approximately 34.1% for additional-rate taxpayers. Carry that doesn't meet the qualifying test is taxed in full as trading income at rates up to 47% including NICs.

The reform also extends the UK's taxing rights over non-UK residents, who are now taxable on qualifying carried interest to the extent it can be attributed to UK workdays.

Rates and thresholds reflect the position as at 20 July 2026. Tax treatment of carried interest is complex and fund (and individual) specific. This note should not be relied on as tax advice.
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How carried interest is taxed in key EU jurisdictions

Tax treatment of carried interest varies significantly across EU member states and, along with the UK's own 2026 reform noted above, several of these regimes have recently changed. The summary below reflects the general position as at 20 July 2026, although treatment may vary depending on the fund structure and specific circumstances. Most jurisdictions offer preferential rates, provided managers meet conditions such as minimum holding periods, co-investment thresholds, and hurdle rates.

This summary is for general information only and is not tax advice. Fund managers should seek jurisdiction-specific advice before relying on any of the rates below.
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How does carried interest vesting work?

Carried interest vesting determines when GPs and investment professionals become entitled to their share of the carry pool. Like equity vesting, it helps retain key talent by linking long-term rewards to continued participation in the fund.
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Vesting terms vary between firms but typically align with the fund’s four-to-six-year investment period. Common approaches include:

• Time-based vesting: Carry vests in equal monthly or annual instalments over a defined period.
• Fund or deal-based vesting: Vesting is tied to the performance of the fund as a whole or to individual investments. Some firms also hold back a portion of carry, typically 10% to 20%, until the fund’s final liquidation, to keep managers invested through the full fund lifecycle.
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Leaver provisions set out what happens when a participant leaves before vesting completes:

• Good leavers: Individuals leaving for reasons such as disability or retirement may keep vested carry (subject to the fund ultimately clearing its hurdle and making distributions) and, in some cases, receive accelerated vesting.
• Bad leavers: Individuals who leave following serious misconduct typically forfeit unvested carry and may separately be subject to clawback of distributions already received.

The future of managing carried interest

As funds grow, so does the complexity of managing carried interest. Tracking allocations, vesting schedules, and leaver provisions across multiple funds and participants is hard to do accurately in spreadsheets alone. Manual processes increase the risk of errors, limit auditability, and make it harder to maintain a single source of truth.

Dedicated carried interest software can automate aspects of administration, help improve accuracy, and give administrators and participants clear visibility into carry allocations throughout the fund lifecycle.

At Ledgy, we’re building a system of record for carried interest that integrates with equity and deferred compensation on a single platform. Instead of relying on disconnected spreadsheets, you can manage carried interest with:

• Automated document drafting and e-signatures
• Real-time participant visibility into carry allocations and vested positions
• Automated support with leaver statement calculations across funds and vesting schedules

Whether you’re administering a single fund or a complex multi-fund structure, a centralised, audit-ready platform can help reduce operational risk and support teams as they scale.

Speak with an expert to see how Ledgy can bring your carried interest administration into one platform.