Offsetting Hedge Fund 457A Deferred Compensation Income Tax
457A Tax Rules Overview
As part of the Emergency Economic Stabilization Act of 2008 (H.R. 1424), section 457A was added to the internal revenue code. This change imposes significant restrictions on techniques commonly used by hedge fund managers to avoid paying U.S. income taxes on fee compensation earned from their offshore funds. Prior to 2009, offshore hedge fund income could easily be deferred and reinvested. However, as part of the Emergency Economic Stabilization Act of 2008, Congress put an end to this practice.
As part of the 457A tax rules change, managers who earned deferred compensation for services performed before January 1, 2009, must repatriate it no later than December 31, 2017. That income then becomes subject to U.S. tax.
However, one strategy for hedge fund managers to reduce potentially high income tax bills is to give a portion of their repatriated deferred compensation to charity. Investing that income into a Donor Advised Fund is considered a charitable contribution for these purposes and Donor Advised Funds are subject to fewer restrictions than private foundations.
National Philanthropic Trust (NPT) may be able to accept an interest in an alternative investment as a charitable contribution and retain an investment in the fund where the donor is a principal or manager. NPT will conduct due diligence to make this determination. The donor may not receive a private benefit from any gift.
Why NPT’s Donor-Advised Funds?
The IRS generally prohibits a private foundation from investing in an alternative investment fund that is managed by a substantial contributor, director, trustee or officer of the foundation. Such an investment by a foundation is considered an act of self-dealing. Moreover, depending on the types of investments the fund makes, it could also be considered a jeopardy investment; that is, an investment that jeopardizes the foundation’s ability to accomplish its mission. These investment rules do not apply to donor-advised funds. NPT may be able to accept and retain an alternative investment. As always, we recommend the donor consult with his/her tax advisor or legal counsel regarding the tax implications of such a gift. NPT’s team of illiquid gift experts is available to assist in the planning.
For more information about how we can assist you or your clients who may have offshore deferred compensation, please contact NPT.