First, let's stop calling it a loophole. That is just an easy way for politicians to try to pass the blame for something that is unpopular. If Congress has known it was there all along then it isn't some loophole, it's the law. Per the article, this has been around since the 1920s, it's the law.
I think of it like the Backdoor Roth. If you have income restrictions on a Roth then any way to get around those income restrictions would seem like a loophole right? When congress decided to ease the restrictions around conversions it was known in advance(by Congress, the IRS, CFPs, CPAs, etc.) that it would allow high income earners to get around the income restrictions on Roth IRAs. If they knew about it in advance then it isn't a loophole. It's the law.
The hedge fund is counting their portion(normally 20%) of the returns as capital gains instead of ordinary income. I see a lot of problems with hedge funds, but this isn't one of them. The "source" of the income is from investment gains. If those investments are held longer than 1 year then they are taxed at LTCG tax rates.
Not only are these hedge fund guys charging ridiculous management fees and taking 20% of the returns, they get preferential tax treatment on the 20% of the returns they are stealing! WTF AMERICA.
I am not a fan of hedge funds. I won't invest in them nor would I recommend others do so. However, the people who are invested in them are accredited(wealthy) investors who know what they are doing. From what I've read many of them know it is likely to perform worse than a balanced portfolio of index funds. They don't care. They see their hedge fund just like their Ferrari that they never drive. It's a conversation starter with other rich people. If one of the hedge funds they are invested in does really well they have bragging rights... as long as they don't bring up how the other ones performed!
Side note: I know a lot of pensions also invest in hedge funds. Those pension managers should be fired. Why on Earth would they put people's retirement money in hedge funds? There isn't any data that I've seen to support doing that, and they are acting as fiduciaries so firing them is the logical conclusion.
