The new **UK carried interest rules** took effect on 6 April 2026 and they change the character of carry, not just its rate. All carried interest is now treated as deemed trading profits within the income tax net, subject to income tax at marginal rates and Class 4 National Insurance contributions, replacing the capital gains framework that governed it before. Carry that meets the qualifying conditions is taxed on 72.5% of its value, producing an effective top rate of about 34.1%. Carry that fails them is taxed in full, at up to 47%.
For a British fund manager that is a rate story: 34.1% against the 32% that applied in 2025/26, with a punitive tier for short-hold strategies. For an American fund manager in London it is something more awkward. The United States has its own carried interest regime in Section 1061, which can still treat carry as long-term capital gain. When one country calls the same receipt earned income and the other calls it capital gain, the foreign tax credit machinery that is supposed to prevent double taxation starts to misfire — and it misfires in the direction of paying twice.
What the new UK carried interest rules actually do
Before 6 April 2026, carried interest was broadly taxed as a capital gain, with a dedicated rate that reached 32% in the 2025/26 tax year. The new regime abandons that architecture. Carried interest is now deemed to be the profits of a trade carried on by the individual, brought into charge to income tax and to Class 4 National Insurance contributions in the same way as self-employed trading profits. The rules apply equally to employees and to self-employed fund managers, which closes the structuring that previously turned on employment status.
The softener is a multiplier rather than a lower rate. Where carried interest is qualifying, only 72.5% of it is brought into charge. For an additional-rate taxpayer that produces 45% on 72.5% of the receipt, plus 2% Class 4 National Insurance on the same 72.5%, giving an effective rate of roughly 34.1% on the gross carry. Where carry is non-qualifying, the full amount is taxed, and the effective rate rises to as much as 47%.
The 40-month average holding period test
Whether carry qualifies turns on the fund's investments, not on the manager's own behaviour. The average holding period condition looks at the weighted average period for which the fund holds its investments, calculated under detailed statutory rules. A weighted average of at least 40 months gives fully qualifying carried interest. Below 36 months, none of the carry qualifies. Between 36 and 40 months there is a sliding scale, so a portion qualifies and the balance does not.
The design deliberately favours long-hold strategies. Traditional buyout and growth equity funds, which typically hold assets for four to six years, comfortably clear 40 months. Credit funds with fast recycling, secondaries strategies, and anything with significant early realisations can find themselves below the line — sometimes because of a single unusually quick exit that drags the weighted average down. The calculation is done at fund level and the manager has limited ability to influence it, which is why the test is now a live consideration in fund documentation rather than an afterthought.
- Weighted average holding period of 40 months or more: carry fully qualifying, taxed on 72.5% of value, roughly 34.1% effective.
- Weighted average below 36 months: none of the carry qualifies, taxed in full at up to 47%.
- Between 36 and 40 months: a tapered proportion qualifies and the remainder does not.
- The test applies at fund level, on a weighted average across investments — one fast exit can move it.
- The rules apply to employed and self-employed managers alike, removing the old status distinction.
Where the US regime disagrees: Section 1061
The United States taxes its citizens on worldwide income, so an American in London reports the same carry on Form 1040 regardless of what HMRC does with it. Section 1061, enacted in 2017, is the US answer to the carried interest debate: it imposes a three-year holding period, rather than the usual one year, before gain allocated in respect of an applicable partnership interest can be long-term capital gain. Fail the three years and the gain is recharacterised as short-term, taxed at ordinary rates.
Clear the three years and the character is long-term capital gain, taxed at 20% plus the 3.8% net investment income tax. That is the ordinary outcome for a buyout fund manager, and it is the source of the mismatch. The same receipt is now, simultaneously, trading income taxed at 34.1% in the UK and long-term capital gain taxed at 23.8% in the US. Two systems, two characters, one payment.
Why the character mismatch breaks the foreign tax credit
The foreign tax credit is not a single pot. Foreign income is allocated to separate limitation categories — principally the general category and the passive category — and foreign taxes are creditable only against US tax on income within the same category. A credit generated in one basket cannot be used against a liability in another, and there is no free movement between them. Alongside that sits the source rule: credits are generally limited to US tax on foreign-source income.
That is where a fund manager gets caught. If the US treats the carry as capital gain, the sourcing rules for gains on personal property generally look to the residence of the seller, which can make a US citizen's gain US-source even though the UK has taxed it as UK trading income. US-source income supports no foreign tax credit. Meanwhile the UK has charged 34.1% on the whole receipt. The result is not a rounding error: it is potentially a full 34.1% UK charge sitting on top of a 23.8% US charge on the same money, with the credit blocked by character and source rather than by any anti-avoidance rule.
Class 4 National Insurance is not a creditable tax
The second half of the new UK charge deserves separate attention. Class 4 National Insurance contributions are social security contributions, not income taxes, and social security contributions are generally not creditable against US income tax under the foreign tax credit rules. The 2% Class 4 element on carry above the upper profits limit therefore has no US offset in its own right.
What governs it instead is the US–UK Totalization Agreement, which allocates social security coverage to one country and exempts the individual from the other's system. A US citizen working in the UK and covered by the UK system is generally exempt from US self-employment tax on the same earnings, which is the relief that matters — but that is a coverage answer, not a credit answer. It removes a second social security charge; it does not make the UK one creditable. The distinction is set out in the IRS guidance on the foreign tax credit, and the UK rates are on GOV.UK.
Timing mismatches make it worse
Even where character and source can be aligned, the two systems rarely tax the same receipt in the same year. The UK charges carried interest as deemed trading profit for the tax year in which it arises, on a 6 April to 5 April basis. The US taxes the partner's allocable share according to the partnership's own tax year, on a calendar basis, and the allocation may fall in a different year entirely from the UK charge.
Foreign tax credits can be carried back one year and forward ten, which absorbs some of this, but only if there is same-category foreign-source income in those years to absorb them. A manager whose carry arrives in a single large year and whose other income is largely US-source can find credits stranded for a decade before they expire unused. Modelling the multi-year position, rather than a single year in isolation, is the only way to see this coming. Our foreign tax credit calculator gives a starting point for the single-year arithmetic.
The territorial question for inbound and outbound managers
The reform also tightened the territorial boundaries. The intention, confirmed through the consultation process, is that non-UK residents are within the charge only in respect of carried interest referable to services performed in the United Kingdom, with a mechanism for apportioning where a manager works across jurisdictions. That is welcome for genuinely mobile professionals, and it makes contemporaneous records of workdays materially more valuable than they were.
It also interacts with the end of the non-domicile regime. A US citizen arriving in the UK under the four-year foreign income and gains regime faces a different analysis from one who has been resident for years, and carried interest referable to UK services does not sit comfortably within a relief designed for foreign income. We cover the wider framework in the abolition of non-dom status and the FIG regime.
How this compares with your other fund compensation
Carry is rarely the only line on a fund professional's compensation statement, and the new rules change its relative position. Management fee income and bonuses were always earned income taxed at up to 47% in the UK and at ordinary rates in the US, with a broadly workable credit position because both systems agree on character. Co-investment returns remain capital in both systems. Carry has now moved from the second group into something that resembles the first in the UK while remaining in the second in the US — the worst of both.
The practical consequence is that the ranking of compensation forms by after-tax value has changed for an American in London. Co-investment, which both systems treat as capital gain, has become relatively more attractive than carry on an after-tax basis in a way it was not before April 2026. The same logic that applies to equity awards, which we set out in US and UK tax on RSUs and stock options, applies with more force here because the character disagreement is now structural rather than incidental.
What to do about it
There is no single election that solves this, which is precisely why it needs to be planned rather than reacted to. The starting point is establishing, fund by fund, whether the carry is qualifying under the 40-month test, because the difference between 34.1% and 47% dwarfs most of the downstream planning. Fund documentation and realisation timing both feed that answer, and managers increasingly have visibility of it in advance.
The second step is the US analysis: whether Section 1061's three-year test is met, what character results, how the income sources, and which credit basket it lands in. The third is the multi-year credit projection, because a single-year view will almost always understate the problem. Where credits would otherwise strand, the levers are the timing of realisations, the composition of other foreign-source income in the relevant basket, and in some cases the structure through which the carry is held — all of which have to be considered before the carry arises.
- Establish the fund's average holding period position early — 34.1% versus 47% is the largest single variable.
- Test the Section 1061 three-year holding period on the US side for each carry allocation.
- Identify the US source and foreign tax credit basket for the carry before the year of receipt.
- Project credits over a multi-year window, not a single year — carryforwards are ten years but need matching income.
- Keep contemporaneous workday records: territorial apportionment now depends on them.
- Re-rank your compensation forms — co-investment is treated as capital by both systems, carry no longer is.
How TaxStone approaches carried interest for Americans
At TaxStone we model carried interest as one receipt across two systems rather than as two separate filings that happen to concern the same money. In practice that means running the UK qualifying analysis and the Section 1061 analysis side by side, mapping the character and source outcome each produces, and then projecting the credit position across the realisation window rather than a single tax year.
The managers who come out ahead are almost always the ones who did this before the carry crystallised. Once a receipt has landed in the wrong year, in the wrong basket, or from the wrong source, the options narrow sharply. If you hold carried interest in a UK fund and file a US return, contact us or book a free consultation and we will map the position across both regimes: /get-started.
The short version
From 6 April 2026 the UK taxes all carried interest as deemed trading profits subject to income tax and Class 4 National Insurance. Qualifying carry is charged on 72.5% of its value, giving an effective top rate of about 34.1%; non-qualifying carry is charged in full at up to 47%. Qualification depends on the fund's weighted average holding period: 40 months or more qualifies fully, under 36 months qualifies not at all, and there is a taper in between. The rules apply to employed and self-employed managers alike, with a territorial limit for non-residents based on UK services.
For an American fund manager in London the rate is only half the story. The UK now treats carry as earned income while Section 1061 may still treat it as long-term capital gain, and that disagreement over character — compounded by source rules, credit baskets, non-creditable National Insurance and mismatched tax years — is what turns a 34.1% UK charge into something closer to genuine double taxation. It is fixable, but only before the carry arrives.
