Carry

Carry is profit participation for private funds...think: venture and private equity. They "carry" away profits above a given level and then buy yachts. Carried interest refers to a share of the profits paid to these managers as compensation for the funds they manage. It doesn't matter whether the hedge fund manager contributed his or her own funds to the investment. They would still receive carried interest.

But in terms of taxes, these payments get capital gains treatment (generally speaking), instead of ordinary income tax treatment if they do contribute their own dough. In this scenario, they become principals in the investments rather than just guns-for-hire. However, the fund must not only generate a profit, it must also exceed a hurdle rate (the target rate of return). Otherwise the fund manager might not receive any carry or could even have to give some back to make up the difference. For example, if the hurdle rate was a 15% annual return and the fund only returns 13%, the fund manager might have to make up the 2%.

This is one reason hedge funds managers maintain that these earnings should continue to be classed as capital gains and not ordinary income for tax purposes.