Carried Interest Planning: 8 Key Questions Every Private Equity Principal Should Ask

By Erik Berge | Senior Wealth Strategist, Citizens Private Wealth

Carried interest often represents one of the most valuable and complex components of a private equity principal's wealth. The tax and estate planning decisions you make around it can shape your long-term outcomes as much as investment performance itself. Whether you are years away from a liquidity event or approaching one now, asking the right questions can help you capture opportunities, avoid costly missteps and align your strategy with both fund rules and evolving tax law.

1. Have you evaluated the potential magnitude of your future estate tax exposure?

Carried interest can create significant exposure across multiple tax fronts, such as estate, income and gift tax, often in ways that compound over time. Fund distribution timing, investor restrictions and varying state rules add layers of complexity that can change the outcome dramatically. Without early modeling and planning, you may face a sizable, unexpected tax bill with limited options to mitigate it.

2. Can you afford to give away some of the personal upside in your carry allocation to achieve broader goals?

Liquidity to fund near-term obligations and investment commitments should be prioritized before committing any part of your carry's future growth to a trust or other recipient. Once ample liquidity is in place, then the upside in the carry can be considered for longer-term goals such as wealth transfer and philanthropy.

Financially, gifting appreciated assets can remove future growth from your balance sheet while allowing that growth to compound elsewhere. Psychologically, it can be harder to part with an asset tied closely to your professional success, especially when the final payout is uncertain.

Effective carried interest planning balances these realities, ensuring today's needs are secure while making the most of tomorrow's opportunities.

3. Do you have the right trust structure(s) in place (IDGT, SLAT, etc.)?

Because carried interest often starts with little to no value and has the potential for substantial appreciation, it presents a rare opportunity to transfer future growth out of your estate at a minimal tax cost if the right trust structure is in place.

An Intentionally Defective Grantor Trust (IDGT) allows you to transfer carried interest outside of your taxable estate while continuing to pay any income tax on the trust's earnings personally. This tax treatment keeps the trust's value compounding outside your estate while paying the trust's annual tax liability may help to reduce your taxable estate and future estate tax exposure over time. IDGTs also support advanced techniques like selling carry to the trust or substituting assets to optimize tax outcomes. However, they must be carefully structured to avoid triggering gift tax under IRC §2701.

A Spousal Lifetime Access Trust (SLAT) can provide indirect access to the gifted carry through your spouse, offering a measure of flexibility while still removing the asset from your estate. This can be especially useful when gifting an asset with uncertain timing and value, like carried interest.

When evaluating trust structures, consider:

• Who the beneficiaries are: Children, descendants or a spouse?
• Whether the trust qualifies to hold carry: Does it meet accredited investor or qualified purchaser standards?
• How the trust coordinates with fund documents. Can carry be assigned before vesting or monetization?
• Where the trust is located. Some jurisdictions offer more favorable rules for long-term planning.

The right structure depends on your goals, your family's needs, and the specific terms of your fund. Getting this right early can unlock significant planning advantages.

4. Will your trust qualify to receive carry under fund documents and investor rules?

Before transferring carried interest to a trust, confirm that the trust meets all eligibility requirements under your fund's governing documents and investor agreements. Many funds restrict who can hold carry, often requiring that recipients be accredited investors (typically with at least $5 million in assets) or qualified purchasers. These rules are designed to ensure compliance with securities regulations and maintain fund integrity.

Additionally, the fund's limited partnership agreement (LPA) or operating agreement may contain provisions that limit or prohibit assignment of carry interests prior to vesting or monetization. Some funds require prior written consent from the general partner or fund counsel before any transfer can occur.

Failing to meet these requirements could invalidate the transfer, trigger adverse tax consequences or even breach fund agreements. That's why coordinating with legal and tax advisors early is so important. If your trust is set up correctly to receive carry, your planning can stay on track.

5. Do you understand the income tax implications of gifting carry to a grantor trust?

Gifting carried interest, especially to a grantor trust, can create a mismatch between ownership and tax liability. For example, if you gift 50% of your carry to a grantor trust, you may still be responsible for paying income tax on 100% of the earnings, even though you only retain half the economic upside.

This strategy can be advantageous from an estate planning perspective: by paying the tax on behalf of the trust, you're effectively making a tax-free gift, further reducing your taxable estate. But it also means you need to plan carefully for liquidity, especially since income from carry may be recognized before you actually receive cash, creating a tax obligation without immediate funds to cover it.

6. Do you have remaining lifetime exemption?

Under the One Big Beautiful Bill Act (OBBBA), the lifetime gift and estate tax exemption is set to rise from $13.99 million in 2025 to $15 million in 2026. This exemption covers the total value of lifetime gifts and bequests, and any amount used during life reduces what's available at death.

Gifting carried interest may require using a portion of this exemption, so it's essential to coordinate with your broader estate planning strategy, especially if you're also transferring other high-growth assets. If your exemption is limited or already used, techniques like selling carry to an Intentionally Defective Grantor Trust (IDGT) or substituting assets may help achieve similar outcomes without triggering gift tax.

7. Are you familiar with the vertical slice safe harbor?

Under IRC §2701, if you transfer only your GP (carried interest) and retain your LP (capital interest), the IRS may treat the gift as having zero value, triggering a deemed gift of the entire entity's value. That's where the vertical slice safe harbor comes in.

To avoid this, you must gift a proportional share of all your interests in the entity, both GP and LP, in the same ratio. This "vertical slice" ensures the gift is respected for valuation purposes and avoids punitive tax treatment.

For example, if you plan to gift 25% of your GP interest but also plan to invest in the LP where you may have a favorable no fee / no carry investment opportunity, you must also allocate 25% of your capital commitment to the trust you gifted carry into. This structure helps preserve valuation discounts and keeps your estate plan on solid ground.

8. Are you prepared for the valuation and compliance requirements?

To complete a gift of carried interest properly, you'll need a qualified appraisal of the carry's fair market value. This often involves discounted cash flow (DCF) analysis or option pricing models, depending on the fund's structure and expected performance.

You'll also need to file Form 709 (the federal gift tax return) and maintain documentation that supports your valuation. While gifting carry is common in estate planning, it can attract scrutiny, so it's important to manage audit risk by working with experienced valuation professionals and tax advisors.

Here to answer your questions

Carried interest planning is complex, but asking the right questions early can help you avoid costly missteps and unlock meaningful long-term opportunities. Whether you're preparing for a liquidity event or just starting to build your strategy, thoughtful coordination across tax, legal, and fund considerations is key. To explore how these strategies apply to your situation, reach out to your Citizens Private Wealth Advisor.