UK carried interest moved into the Income Tax framework in April 2026. What that means for US citizens in London funds, and why foreign tax credits misfire.
Carried interest is the slice of a fund's profits that goes to the people who manage it, once investors have had their capital back and a preferred return. For a US citizen in a London fund the difficulty is no longer the waterfall arithmetic; it is that from 6 April 2026 the UK taxes carried interest inside the Income Tax framework as the profits of a deemed trade, while the US continues to treat carry as a partnership profits interest whose character follows what the fund actually earned. When one country calls a receipt income and the other calls it capital gain — and the two tax it in different years — the tidy foreign tax credit story that works for salary stops working.
This is a fast-moving area. The UK regime changed twice in quick succession, and the treatment of any carry arrangement depends on the fund's structure, the individual's residence history and the year in question. Everything below describes mechanisms; the position for your fund and your year must be confirmed against the enacted legislation before you rely on it.
A note on status. The revised regime was set out by the government on 21 July 2025, with legislation introduced in Finance Bill 2025-26 to have effect on and after 6 April 2026. Detail can move between announcement and enactment, so confirm the final legislated position for your fund and your tax year before relying on any figure here.
Carried interest is a performance-linked share of a fund's profits allocated to its managers through the fund partnership, rather than paid to them as a fee. It typically arises only after investors have received their capital back with a preferred return, or hurdle, so it is economically a reward for performance and legally a partnership entitlement.
Two distinctions matter before any tax analysis begins:
The UK's revised tax regime for carried interest has effect on and after 6 April 2026. The design is a deliberate change of framework rather than a rate tweak: carried interest is treated as trading profits and subject to Income Tax and Class 4 National Insurance contributions, and the draft legislation achieves this by treating the individual as carrying on a trade for the relevant tax year.
Three features are worth holding on to:
For the immediately preceding year there was an interim step: the government consolidated the normal and higher rates of Capital Gains Tax on carried interest into a single unified rate of 32% from April 2025. That matters if you have carry recognised across the boundary, or foreign tax credit carryovers generated under the old framework.
The US analysis starts somewhere else entirely. Carry is a profits interest in a partnership, and IRS Publication 541 states that where a person receives a profits interest for providing services to or for the benefit of a partnership in a partner capacity, or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership — subject to exceptions, including interests relating to a substantially certain and predictable stream of income and interests disposed of within two years.
What you are taxed on, then, is the allocation. Partnership items retain their character as they pass through to partners, so the carry allocation is taxed according to what the fund actually earned: long-term capital gain, short-term gain, dividends, interest and so on, each reported through your Schedule K-1. If you are new to reading one, our guide to reading a K-1 as a partner sets out the mechanics.
On top of that sits section 1061. The IRS states that section 1061 recharacterizes certain net long-term capital gains of a partner who holds one or more applicable partnership interests as short-term capital gains, and that the provision generally requires a capital asset to be held for more than three years for gain allocated with respect to an applicable partnership interest to be treated as long-term. An applicable partnership interest is broadly one transferred to, or held by, a taxpayer in connection with the performance of substantial services in an applicable trade or business. The reporting is specific: pass-through entities attach the relevant worksheet to the API holder's Schedule K-1, and the owner taxpayer uses that information to compute the amount recharacterised and attaches supporting schedules to the return.
So the US answer is not one answer. It is a characterisation exercise, asset by asset, year by year.
Put the two systems side by side and the collision is obvious. Britain now asks one question — is this carried interest, and is it qualifying — and taxes the answer as the profits of a trade. America asks a different question — what did the fund earn, and how long did it hold the asset — and taxes each strand on its own terms.
The practical consequences fall out quickly:
Character is only half the difficulty; timing is the other half. The UK tax year and the US calendar year do not match, funds distribute on their own schedule, and the point at which each system recognises a carry receipt can fall in different years. Escrow, clawback and deferral arrangements pull the two further apart.
This is what breaks the foreign tax credit. A credit relieves tax in the year it belongs to: Publication 514 explains that a cash-basis taxpayer can claim the credit only in the year the tax is paid, and an accrual-basis taxpayer only in the year it accrues. If the UK charge lands in one year and the US income in another, the credit does not wait for it.
Even where the years align, the credit is not a single pot. IRS Publication 514 computes the limit separately for each category of income — passive category income, general category income, foreign branch category income and others — and is explicit that the credit can only reduce US tax on foreign source income. Excess credit sitting in one category does not relieve tax in another.
For a carry receipt this is where the money is won or lost. UK tax charged on what Britain now calls trading profits must be matched against US income in a compatible category, from a compatible source. Where it cannot be, the result is real double taxation, and the residue lands in the carryover mechanics we cover in foreign tax credit carryovers for US expats — where unused credits can generally be carried forward for up to 10 years, but only within the category that generated them. Carryovers that can never be used are simply a cost.
Keeping co-investment separate from carry is one of the highest-value pieces of record-keeping a fund professional can do. The return on personally committed capital should be traceable to a contribution you actually made. Carry is performance-linked and has a different analysis on both sides of the Atlantic.
In practice the two are frequently commingled: the same partnership, the same capital account, the same annual statement. If your own records do not show contributed capital, distributions of that capital, and performance allocations as distinct lines, reconstructing the distinction under enquiry — in either country — is expensive and uncertain.
Limited partnership agreements, side letters and the fund's annual tax pack are drafted for the fund and its investor base. They allocate, they report, and they satisfy the fund's own obligations. They are not written for one American partner's Form 1040.
That means the tax pack will not tell you how a receipt is characterised for US purposes, whether section 1061 recharacterises part of it, which foreign tax credit category the UK tax belongs in, how sterling figures translate on the relevant US dates, or how UK and US recognition years interact. It is source data. Reconciling it to your personal position is separate work, and it is best done before the carry arrives rather than in the following filing season.
We start by mapping the arrangement: what the documents actually give you, what is carry and what is co-invest, when each country recognises it, and what the fund's characteristics mean for the UK qualifying test and the US holding-period test. Only then do we model the credit position, category by category, in both currencies.
Our US-UK expat tax practice handles the personal return; where the arrangement runs through your own management company or a partnership you control, cross-border business tax picks that up alongside it. A licensed CPA or Enrolled Agent reviews and signs off every filing that leaves the firm. If you hold carry in a UK fund and are a US person, book a confidential consultation before the next distribution rather than after it.
This article is general information, not tax, investment or legal advice, and does not create a professional relationship. The UK carried interest regime has changed recently and further guidance and legislation may follow; US rules, fund terms and individual residence positions all affect the outcome. Confirm the current position for your specific fund and tax year with a licensed professional before acting.
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Reviewed by a CPA / Enrolled Agent. Last updated: 12 September 2026.
Official sources: GOV.UK — Revised tax regime for carried interest | GOV.UK — Reform of the tax treatment of carried interest: draft legislation | GOV.UK — The Tax Treatment of Carried Interest: government response and policy update | GOV.UK — Carried interest: rates of Capital Gains Tax | HMRC — IFM37120, Definition of carried interest | IRS — Section 1061 reporting guidance FAQs | IRS — Publication 541, Partnerships | IRS — Publication 514, Foreign Tax Credit for Individuals