Client Advisory PDF & Printable Version
Congress is possibly considering various tax law changes that could affect investment funds. First, congressional committees are reportedly discussing whether the "carried interest" paid to an investment fund's general partner should be taxed as compensation income instead of capital gains. Such a change would be significant by increasing the federal income tax on the income from a carried interest from 15% to 35%. The focus of the change appears to be directed to the carried interest paid to hedge fund managers, but could apply to the carried interest paid to the general partners of private equity and venture funds depending on the final language of any bill or legislation that develops from these committees. There is little information about what is being discussed and no proposed legislation has been drafted at this time. We will keep you updated as more information is released.
Congress is also continuing to look at changes in the tax laws that include a limitation on the amount of compensation a person can defer per year and whether waivers and deferrals of management fees constitute deferred compensation. A current bill would limit the amount of deferred compensation per year to the lesser of $1 million or the five year average of the taxable compensation paid to such person. Deferring or waiving management fees by fund managers in exchange for future gains of the investment fund have become a popular mechanism over the years and used by many private equity and venture capital funds. It is unclear at this point to what extent Congress intends to treat waived and deferred management fee arrangements as deferred compensation, if at all. Congress has been looking at this issue since 2004 when it enacted Section 409A of the Internal Revenue Code. Proposed Regulations promulgated under Section 409A suggested that deferred management fee arrangements could be subject to the negative consequences of Section 409A depending on how much control the fund managers had over when such deferred fees would be paid to them. Final Regulations promulgated under Section 409A are expected to be issued before June 30, 2007 and hopefully will provide guidance on which waived and deferred management fee arrangements are at issue under Section 409A. We will give you an update once more guidance is issued.