Preparing for the Sunset: 457A Income Tax Strategies for Private Fund Managers


Effective at the end of 2017, hedge fund principals and private equity managers must repatriate management and incentive fees earned prior to 2009 that are held within offshore funds. As a result, any income earned by these offshore funds before 2009 and any appreciation will be taxed as ordinary income for the 2017 tax year. And, without proper planning, these assets could also be subject to federal and state estate taxes.

Charitable Giving Strategies Can Help Mitigate the Tax Impact of Income Accumulated from Deferred Compensation

While taxes cannot be avoided, they can be managed.

The unique tax situation in 2017 provides a great opportunity to make a charitable impact. Because deferred compensation earned prior to 2009 will be taxed on your 2017 tax return, it is important take steps before the end of the year to achieve the most advantageous tax and philanthropic results.

What to Give, and How to Give It

Deciding which assets to give and which gifting vehicles to use will differ based on your situation and preferences, but there are several common factors to consider.

Look at Deduction Limits

The amount of your charitable contribution you can deduct differs based on whether the donation is made to a public charity or donor advised fund versus a private foundation, and whether the donation is made in cash or appreciated securities.

Contributions of cash to qualified charities or donor advised funds can be deducted up to 50% of your adjusted gross income (AGI), while cash donations to charitable trusts or private foundations can be deducted up to 30% of your AGI. If you donate appreciated assets, the limits are lower; 30% of your AGI for public charities and 20% for private foundations.

Keep in mind there is a five-year carry over period, so even if your gift exceeds the AGI threshold in the current year, a deduction can be applied over the next five years (again subject to the AGI threshold for each succeeding year).

Gifting Appreciated Securities Can Increase Your Tax Break

Despite the lower deduction limit, gifting appreciated assets can often make sense from a tax perspective. You will avoid the capital gains tax that would otherwise be due, and the full fair market value of the shares you donate can be claimed as a tax deduction, even if your cost basis for those securities is much lower (as long as you held them for greater than one year). 

Rather than Gifting Outright, Consider Charitable Giving Vehicles

Instead of gifting cash or securities directly, gifting vehicles can offer additional benefits. Choosing the right one for you will depend on several factors, including how much you are donating, your philanthropic goals and desired long-term outcome.

  • Donor Advised Funds: Make a Gift in the Current Year, Select Your Charity in the Future

Donor advised funds offer a high up-front tax deduction (as much as 50% of AGI for cash and 30% for securities) and you can donate shares of your private equity fund or hedge fund directly to the donor advised fund.

Other advantages include immediate tax deductions for donors, tax-free growth of investment gains (even before you decide on a charity to support) and few restrictions on investments.

In addition, contributions of stocks that are not publicly traded may be deductible at fair market value (versus cost basis for similar contributions to private foundations). Assets contributed to a donor advised fund will also be removed from the value of your estate for federal estate tax purposes, and are not subject to probate.

  • Charitable Lead Annuity Trusts: Benefit a Charity and Your Heirs

CLATs allow you to donate to charity while also transferring assets to heirs free of gift and estate taxes. Tax deductions are allowed for the present value of the annuity: up to 30% of AGI for cash and/or securities. Any appreciation of assets that is above an IRS-established interest rate transfers to your heirs free of gift and federal estate taxes. Therefore, CLATs can be an attractive option for those who are charitably inclined but also would like to benefit heirs. 

For the greatest tax benefit, the CLAT can be structured in a way that makes the entire funding amount equal to the present value of the charitable annuity stream (known as a “zeroed-out CLAT”). Any appreciation of assets in the CLAT above the discount rate (2.4% as of September 2017) will be left in the trust when the annuity period ends, and this amount transfers to heirs free of gift and federal estate taxes.

The potential downside is that CLATs have lower up-front tax deductions and may have restrictions on investment choices. Donors are also responsible for paying taxes on any income the trust earns during the annuity period. (Some people choose to mitigate this tax by using private placement life insurance solutions.) And, CLATs are not eligible for the Generation-Skipping Transfer Tax exemption at funding.

  • Private Foundations: Provide Control and Ability to Get Involved

Creating a private foundation offers a great degree of flexibility and control because you can determine the foundation’s goals and who receives the gift; however, donations can be highly restricted and tax deductions are lower—up to 30% of AGI for cash and 20% for securities. In addition, the IRS generally prohibits a private foundation from investing in a fund that is managed by a substantial contributor, director, trustee or officer of the foundation.

Take Action Before Year End

Please reach out to your Fiduciary Trust representative to discuss in more detail, as we welcome the opportunity to provide in-depth analysis on your personal wealth and securities to optimize your 2017 gifting strategy.

This communication is intended solely to provide general information. The information and opinions stated are as of September 5, 2017, and may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process.Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.


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