The passage of recent tax legislation has brought welcome clarity to estate planners and private investors alike. With the federal estate and gift tax exemption now fixed at $15 million per individual and $30 million per married couple, the stage is set for strategic long-term planning. With the exemption at historically high levels and the rules finally settled, general partners (GPs) in private equity and venture capital funds have the opportunity to secure meaningful estate tax savings by transferring carried interest before it appreciates.
Despite accounting for the majority of most GPs’ compensation, carried interest (carry) is often overlooked in estate planning conversations. Its value is uncertain, its mechanics are complex and its future is clouded by political attention. Yet a properly executed early-stage transfer of carry can shift tens of millions of dollars in future growth outside a GP’s estate. The key is not just to identify the opportunity but also to execute the valuation and structure it with discipline and precision.
Why Carried Interest Is Different
Carried interest is a contingent right to receive a share of future profits, typically after limited partners have received their capital back and a preferred return. This structure defers any real value of the carry until portfolio companies are monetized and the fund’s hurdle is cleared. As a result, carried interest has limited value in the early years of a fund, even though it may one day be worth a fortune. The gap between present valuation and future potential is what makes carried interest such a valuable tool for estate planning.
Unlike traditional equity or cash-generating assets, carry can be valued at a steep discount to its future value if it’s transferred early. The absence of guaranteed returns, plus illiquidity, clawback risk and the fund’s long investment cycle, all suppress the fair market value of carry. When carry is gifted or transferred before exits begin, it consumes very little of a partner’s lifetime exemption but still allows financial upside to accrue to the next generation of a partner’s family.
Once the fund reaches its harvest stage and starts producing distributions, however, the value of the carry increases quickly. At that point, the planning window begins to close. Early action is essential.
How to Value Carry
A credible carried interest strategy depends on the quality of the valuation. A proper valuation doesn’t rely on theoretical models or general assumptions. It requires a bottom-up analysis built from the fund’s specific mechanics. That means reading the limited partnership agreement closely, modeling the cash flow “waterfall” accurately and applying realistic assumptions about timing, performance and risk of investments.
The most defensible method for valuing carry is a discounted cash flow model that reflects the fund’s projected economics. This model should incorporate the hurdle rate, catch-up provisions, clawback mechanics, recycling of capital and timing of exits. From there, a range of scenarios can be projected based on expected performance and potential portfolio outcomes. The resulting distribution estimates are then discounted to present value and discounted for restrictions on control and marketability.
This approach results in a valuation that mirrors how a rational buyer would approach the carry by considering uncertainty, timing and structural hurdles. Thus, the valuation stands up to scrutiny, supports adequate disclosure on gift tax returns and helps avoid Internal Revenue Service challenges that may arise from generic or unsupported appraisals.
The most common mistake we encounter when valuing carried interest is using template-based models that apply public equity volatility, market-based option pricing or arbitrary discounts without considering fund specifics. These models may yield numbers on paper, but they often misstate the real economics of the carry and can leave the transfer exposed to audit risk.
Structuring the Transfer
There are two main ways to structure a carry transfer:
1. Vertical slice involves transferring a proportionate share of both the direct interest and the carried interest in a fund. This structure is consistent with the safe harbor under Internal Revenue Code Section 2701 and is widely accepted. A typical example might involve gifting 50% of a GP’s direct interest and 50% of their carried interest. This approach is straightforward and minimizes valuation risk. However, due to the inclusion of the direct interest, it may use up more of a partner’s gift/estate tax exemption than desired.
2. Derivative-based planning involves contractual structures that transfer the economic benefits of carry without transferring legal ownership of the GP interest itself. These tools allow GPs to isolate and transfer the high-growth portion of their economics without triggering additional ownership complications.
The valuation of derivative structures still relies on discounted cash flow modeling, but the focus shifts to the specific terms of the derivative. While these arrangements require more complex legal work and thoughtful coordination, they offer greater flexibility than a vertical slice and often allow more efficient use of the available exemption.
The choice between using the vertical slice or derivative structure depends on multiple factors, including fund governance, family planning goals, exemption availability and timing. Both structures can be effective when implemented correctly.
A Strategic Advantage
Carried interest planning is about recognizing and acting on a time-sensitive opportunity. For many GPs, carry is their largest source of future wealth. Treating it like any other asset overlooks its unique structure and timing. A well-executed plan can result in significant tax savings, greater flexibility for future planning and long-term benefits for family and legacy.
This type of planning work requires a team that understands both fund mechanics and estate tax strategy. Valuation professionals must be able to interpret fund documents, build custom models and articulate the rationale for assumptions. Legal and tax advisors must ensure that the structure fits within the broader plan. The best results come from collaboration, precision, and early action.
If you are a general partner, advisor or family office professional evaluating wealth transfer options, carried interest deserves serious consideration. The opportunity is real, the tools are available and the time to act is now.
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