This week, Mirit Eyal (Alabama; Google Scholar) reviews a new work by David Elkins (Netanya; Google Scholar) & Christopher H. Hanna (SMU; SSRN), Unlocking the Mystery of Private Equity: A New Tax Paradigm, 29 Fla. Tax Rev. 602 (2026).

This review is offered as a tribute to Judge Richard A. Posner, who died on November 10, 2026, at age 87. Over 36 years on the Seventh Circuit and five decades of scholarship, Judge Posner taught tax lawyers, among many others, to ask what a hypothetical rational market participant would actually agree to. Elkins and Hanna’s article, which tests every carried interest model against what real investors and managers would bargain for, is very much in that tradition.

Carried interest may be the only tax break that both parties’ leaders have promised to end and that Congress keeps leaving in place. In February 2025, President Trump told Republican congressional leaders that “closing the carried interest tax deduction loophole” was one of his main tax priorities. A few months later, the One Big Beautiful Bill Act was signed on July 4, 2025, without any carried interest provision, leaving § 1061 and its three-year holding period as the only real constraint. Democrats then took up the issue again. On April 16, 2026, Senators Wyden, Whitehouse, and King introduced the Ending the Carried Interest Loophole Act (S. 4330). The bill would repeal § 1061 and replace it with a new § 1299 built around a deemed income recognition concept, requiring fund managers to recognize annual compensation taxed at ordinary rates. The Yale Budget Lab estimated that the proposal could raise about $87.7 billion over ten years, almost twice the earlier estimates. The politics have changed. The basic conceptual question has not.

That is why the Elkins and Hanna article is so timely. The design that S. 4330 adopts, which the Real Estate Roundtable describes as treating carried interest as an interest-free loan from the investors, is essentially the deemed loan model that the article analyzes and rejects. The article is not a brief for or against the current bill. It asks a more basic question that legislators have mostly skipped, that is what kind of income is carry? Their answer is that it is capital gain in character but compensation for skill in substance. If that is right, the 2026 proposals are reaching the right result for the wrong reasons, through a legal fiction the article shows cannot be made to fit the actual contract.

The article begins with the economics of the typical “two and twenty” arrangement. The manager, usually itself a tax partnership, contributes little or no capital, serves as general partner, and receives an annual fee of about two percent of fund assets plus a 20 percent share of profits. That share is sometimes payable only above a hurdle rate of around eight percent. The manager does not share in fund losses, and its fixed fee is unaffected by them. The fee is clearly ordinary income, taxed as a § 707(c) guaranteed payment. The tax treatment of the carry is much less settled. The article then shows that every existing approach fails to describe what a carried interest actually is. Under current practice, Rev. Proc. 93-27 provides that receiving a profits interest is not a taxable event, the income keeps its partnership-level character, and the manager pays tax at capital gains rates. That approach ignores the fact that the manager is paid for services, not for an investment.

The deemed loan model, associated with Cunningham and Engler, treats a manager holding 20 percent of the profits of a $100 million fund as having borrowed $20 million interest-free from the investors and invested it in the fund. Because the investors can dismiss the manager at any time, the loan is treated as a demand loan under § 7872. With a five percent federal short-term rate, the manager would report $1 million of compensation income each year and an offsetting $1 million of investment interest expense, deductible only to the extent of net investment income under § 163(d). Elkins and Hanna show in detail that this fiction does not match the actual contract. If the fund loses $10 million, the model has the manager absorb $2 million, but in reality the manager loses nothing. The manager’s exemption from losses is itself compensation, and courts have recognized that its value cannot be determined in advance.  

The compensation model, which is closer to the approach of the Carried Interest Fairness Act of 2025, gets the economics right according to Elkins and Hanna by recognizing that managing assets is the manager’s only contribution. But it conflicts with a basic rule of subchapter K. Under § 702(b), character is determined at the partnership level and flows through to the partners. Elkins and Hanna give an example. A partner who contributes only capital to an operating business still receives business income, even though additional partner-level attributes, such as the § 469 passive activity limits, may also attach. The compensation model also departs from the timing rules, because partners are taxed on their distributive shares as the partnership earns income, not when amounts are distributed. A workable approach, Elkins and Hanna conclude, has to respect three facts at once. The manager receives a share of fund income, that income keeps its character, and the manager receives it because of the services it performs.

The supernormal return model is designed to meet all three conditions. Elkins and Hanna divide investment return into three parts: the risk-free return (compensation for deferring consumption), the risk premium (compensation for bearing risk), and the supernormal return (compensation for skill). The risk-free return, illustrated by Treasury bills, is the clearest example of a return to capital. The risk premium is more subtle. Under a normative income tax with fully deductible losses and symmetric rates, the risk premium is effectively untaxed. Asymmetric rates break that neutrality. If gains are taxed at preferential rates while losses would offset ordinary income, the risk premium is effectively subject to a negative tax.

Supernormal returns are different in kind. They are returns to skill, earned for example by spotting cases where the market overestimates risk. They are not returns to capital, which Elkins and Hanna show by noting that a person with skill but no capital can earn them by pairing that skill with someone else’s money. A carried interest fits this framework well. The manager contributes no capital and defers no consumption, so none of its share can be a risk-free return. Elkins and Hanna answer the objection that this conflicts with flow-through character by distinguishing two classifications. The technical character of income (interest, dividends, capital gain) is fixed at the partnership level, but its economic classification (risk-free, risk premium, or supernormal) is a conceptual question that depends on each partner’s contribution. The investors hire the manager for its proven or presumed ability to beat the market, so the manager’s share is supernormal.

The article’s most original move is its explanation of why the manager and the investors should be taxed differently when both may earn supernormal returns. Elkins and Hanna draw on the long-accepted distinction between services people supply to themselves and services they supply to others. Painting one’s own house goes untaxed, while trading services with a neighbor or earning wages to pay a painter does not, a horizontal inequity usually justified on practical grounds. Investors’ supernormal returns, which reflect their skill in choosing a manager, are self-supplied and cannot be measured, so the tax law ignores them. The manager’s supernormal return comes from services supplied to others, so it can be readily identified and measured. The income therefore can remain capital gain in character but still be taxed at ordinary rates.

Readers of Judge Posner’s tax opinions will recognize the logic. In Exacto Spring Corp. v. Commissioner, 196 F.3d 833 (7th Cir. 1999), and again in Menard, Inc. v. Commissioner, 560 F.3d 620 (7th Cir. 2009), Judge Posner rejected the vague multifactor tests for reasonable compensation under § 162(a)(1) in favor of the “independent investor” test. An outside investor will not begrudge an owner-employee a large salary if the equity return remains satisfactory, because the salary is then plausibly the price of the executive’s contribution to the company’s success. The test splits the owner-employee into two people, an investor and an employee, and asks what the investor would pay the employee for his skill. Elkins and Hanna run the same thought experiment in reverse. In private equity the split is real. The limited partners are the independent investors, and the 20 percent they cede to the manager is what they are willing to pay for skill that beats a market return. Posner’s test, like the supernormal return model, measures the value of services by the return above what capital alone would earn. In Menard, Posner mocked the Tax Court for reasoning that, taken seriously, implied that reasonable compensation for a founder who “really does do it all himself” might be zero. Where Posner used the independent investor to decide whether a payment is really compensation, Elkins and Hanna use the same figure to decide whether a share of capital gain is really compensation. In both cases the answer depends on the bargain an arm’s-length capital provider would strike for skill.

There are also several places where the article could push its analysis further. The first is implementation. The article does not say whether its approach would replace § 1061, and it does not engage the competing legislative designs such as the Greenbook’s investment services partnership interest proposal, the Carried Interest Fairness Act’s recharacterization of gain, and S. 4330’s deemed-compensation regime. A short legislative sketch showing how a supernormal return regime would be drafted would make the article directly useful to the drafters now at work. The second is the investor side. The article recognizes that if the manager’s share is ordinary income, the investors arguably should receive an ordinary deduction, but it largely sets the point aside because many investors are tax-indifferent. Because revenue estimates like the Budget Lab’s depend on behavioral and symmetry assumptions, this point deserves fuller treatment. The third is the line between supernormal returns and luck. Elkins and Hanna note that supernormal returns may also be windfalls. They also do not reconcile the fact that the manager’s choice of carry over a fixed fee seems to produce a risk premium as well as a supernormal return. The fourth is structural variation. Management fee waivers, clawbacks, and managers’ modest capital contributions are mentioned in passing, yet these are where industry advocates, such as real estate sponsors, make their strongest case against reform.  

Nonetheless, Elkins and Hanna make a real contribution to a debate that political momentum alone has not resolved. Rather than forcing a choice between capital and labor, they explain why carried interest income can be both. It is capital gain in character and compensation in substance. Their framework respects the core principles of partnership taxation while explaining why the manager’s share should be taxed at ordinary rates. It also links the carried interest debate to the broader supernormal return literature that already shapes regimes such as GILTI. With a new deemed-compensation bill now pending in the Senate, the article reminds lawmakers that how they reach a result matters as much as the result itself. Few judges did more than Judge Posner to insist that tax law follow economic substance, and this article would have given him much to argue with, and to approve.

Here is the rest of this week’s SSRN tax roundup:

Reuven S. Avi-Yonah (Michigan), Loper Bright, the IRS, and the Supreme Court (Nov. 9, 2026)

Reuven S. Avi-Yonah (Michigan), Should Large Partnerships Be Taxed as Corporations? (Oct. 30, 2026)

Reuven S. Avi-Yonah (Michigan), The Practical Effects of Side by Side (Nov. 9, 2026)

Oktra Basanto (Indonesia), Evaluation of the Effectiveness of Tax Reform in Increasing State Revenue (Oct. 18, 2026)

Joshua D. Blank (UC Irvine) & Ari Glogower (Northwestern), Rethinking Taxpayer Purpose, 53 J. Legis. (forthcoming 2027)

Murillo Campello (Florida, Business) & Guilherme Junqueira (Florida, Finance), Democratizing Venture Capital: Tax Incentives and the Geographic Expansion of Startup Investing (Sep. 17, 2026)

Roger Colinvaux (Catholic), Comment of Professor Roger Colinvaux to Proposed Regulations, Racial Nondiscrimination in Private Schools, REG-119986-25, RIN 1545-BS05, 91 Fed. Reg. 56,811 (Sep. 4, 2026)

Sergey Demyanov (Independent), Assessment Without Appraisal (Nov. 9, 2026)

Sergey Demyanov (Independent), Valuation by Open Refusal (Nov. 9, 2026)

Kenny Dekoster (France), Isabelle Verleyen (Belgium) & Annelies Roggeman (Belgium), Tackling Tax Avoidance: Cultivating Ethically Sensitive Tax Professionals Through Education?, J. Acct., Auditing & Tax’n (forthcoming)

Chania Dusi (Indonesia) & I Made Arjaya (Indonesia), Tax Law and the Challenges of Tax Enforcement in the Digital Economy (Nov. 6, 2026)

J. Clifton Fleming (BYU), Robert J. Peroni (Texas) & Stephen E. Shay (Boston College), The United States as a Tax Cut Competitor in a Time of Large Deficits, 193 Tax Notes Fed. 547 (Oct. 19, 2026)

Philip Hackney (Pittsburgh) & Ellen P. Aprill (Loyola L.A.), Comments on Proposed Regulations, Racial Nondiscrimination in Private Schools, IRS REG-119986-25, 91 Fed. Reg. 56,811 (Sept. 4, 2026) (Nov. 4, 2026)

Błażej Kuźniacki (Poland), Neutralizing EU Anti-Hybrid Rules Through Third-Country Tax Treaties (Nov. 2, 2026)

Rogers Niwagaba (Unaffiliated), Automated Payment Registration Number (PRN) Verification, Manual Receipting Elimination, and Fraud Risk Control in Non-Tax Revenue Collection in Uganda: A Case of Kampala Capital City Authority (Oct. 26, 2026)

Milan Perazich (Independent), Verification Architecture and the Displacement of Public Reporting in the United States Carbon Storage Credit (Nov. 9, 2026)

Milan Perazich (Independent), Who Absorbs the Shortfall? Derisking and the Selection of Conditions in North American Carbon Capture Subsidies (Nov. 9, 2026)

Milan Perazich (Independent), Who Publishes the Tonnes? Section 6103, Treasury Authority, and Public Accountability for Carbon Storage Credits (Nov. 9, 2026)

Rosalia Rosal (Philippines), KAPI Insurance Fraud and KAPA Investment Scam: Chronology of Faith-Based Wealth Transfer in the Philippines (Nov. 8, 2026)

Blaine Saito (Ohio State), Democratic Equality and Taxation, 6 Am. J. L. & Equality 230 (2026)

Chris William Sanchirico (Penn) & Reed Shuldiner (Penn), Circular Partnerships: Pinpointing the Problems, Proposing Solutions, 193 Tax Notes Fed. 677 (Oct. 26, 2026)

Bret Wells (Houston) & Reuven S. Avi-Yonah (Michigan), Textualism, Absurd Anomalies, and Tax Logic (Nov. 9, 2026)