The Carry Rule

The Washington Post has a good piece on the taxation of money managers (equity and hedge funds):

Instead of money, the managers contribute primarily their expertise to the venture. They raise the money, select the buyout targets and work to make the companies profitable. For that, they are typically rewarded with a 2 percent annual management fee and a 20 percent share of profits when the firm's portfolio of companies is sold, an arrangement known as '2 and 20.' The 20 percent profit share is called the carried interest, and private-equity managers treat it as a capital gain.

The debate raging on Capitol Hill revolves around whether managers should continue to claim the payout as a capital gain as the other partners do, or whether they should characterize it instead as compensation for labor."

A capital gain generally has a cost basis. There does not seem to be any cost basis of income at 20% of profits. There is no risk loss in terms of income (ie the fund manager doesn't pay back 20% of losses). This should be rather clear cut, don't you think?