The IRS recently stated that it is examining the use of management-fee waivers by private equity firms. This practice typically involves a private equity firm voluntarily waiving the management fees due to it from the fund and instead, requiring investors to contribute an amount equal to those waived fees to satisfy the sponsor’s own capital commitment to the funds they manage. This strategy is typically followed to achieve deferral and obtain a more favorable capital-gains tax treatment for items that would otherwise be taxable as ordinary income.
Many of the largest private equity firms have taken advantage of this strategy, employing various positions along the spectrum from conservative to more aggressive approaches from a tax standpoint. Tax experts have noted that the IRS’s examination into this practice suggests the IRS may be considering the legalities and nuances of the management-fee waivers.
At this time, however, it does not appear that the IRS has actively engaged with tax attorneys, private equity firms, or other experts within the industry on this issue. Private equity firms that employ management fee-waivers may want to consider engaging their tax counsel to discuss the aggressiveness of their position and potential consequences.