Clos­ing a hedge fund tax loop­hole should keep lawyers busy and char­i­ties happy

▶Their lawyers and tax plan­ners are look­ing for ways to min­i­mize the bite ▶“In this cat-and-mouse game, the ad­vis­ers have the edge”

Bloomberg Businessweek (Asia) - - CONTENTS - Kather­ine Bur­ton and Mar­garet Collins

Some of the rich­est money man­agers in the U.S. are about to get a heavy tax bill. They’ve had eight years to dream up a way around it. So far, not much luck—al­though they may have found a way to get their heirs a break.

On Dec. 31, 2017, a loop­hole is set to close that al­lowed hedge fund man­agers to keep cer­tain earn­ings parked off­shore. Some man­agers have al­ready brought the money home and paid the taxes due. Oth­ers have been wait­ing un­til the last mo­ment so they can ben­e­fit from the magic of tax-free com­pound­ing for as long as pos­si­ble. Es­ti­mates by lawyers in the field—based on their con­ver­sa­tions with clients, bro­kers, and fund-ser­vice providers— put the amount of cash about to be sub­ject to tax at $100 bil­lion or more.

Money man­agers “fig­ured that by the time we got to 2017, some­one would have found a way to elim­i­nate all of the tax,” says Richard LeVine of Withers Bergman, a law firm that’s a pi­o­neer in tax plan­ning for the ul­tra­wealthy. That didn’t hap­pen. “Now we are half­way through 2016, and it’s go­ing to get very busy,” he says.

The ex­perts’ fail­ure to find a per­fect fix is good news for the U.S. Depart­ment of the Trea­sury and some states, in­clud­ing Con­necti­cut and New York, where many hedge fun­ders live and work. The money will be taxed as or­di­nary in­come, and the com­bined tax re­ceipts could reach tens of bil­lions. Char­i­ties could ben­e­fit, too, be­cause the best way for the rich to cut li­a­bil­i­ties is to donate to an IRSap­proved cause.

Hedge funds cre­ate off­shore en­ti­ties in tax havens such as the Cay­man Is­lands to man­age money for clients who are not sub­ject to U.S. taxes. Man­agers have been able to keep the fees they earn for run­ning those funds off­shore and un­taxed, as long as the money stays in­vested. In 2008, though, Congress de­cided the man­agers would have to rec­og­nize that

in­come by the end of 2017. The Joint Com­mit­tee on Tax­a­tion fig­ured the tax-code change would gen­er­ate about $25 bil­lion over the en­su­ing decade, in­clud­ing $8 bil­lion in 2017.

Tax lawyers say the panel’s rev­enue fore­casts are low, based on what they know about a few in­di­vid­u­als who to­gether could ac­count for a big chunk of the es­ti­mate. Ge­orge Soros, for ex­am­ple, was by the end of 2013 hold­ing $13.3 bil­lion in de­ferred in­come off­shore in Soros

Fund Man­age­ment, ac­cord­ing to Ir­ish reg­u­la­tory fil­ings. Soros de­clined to com­ment.

Hedge fund man­ager David Tep­per, once the wealth­i­est res­i­dent of New Jersey, de­camped last year to Florida, where the state in­come tax is zero. A per­son with knowl­edge of his think­ing says Tep­per moved to Mi­ami Beach pri­mar­ily for fam­ily rea­sons but that min­i­miz­ing his New Jersey taxes was also a fac­tor, with the 2017 dead­line loom­ing.

The ma­neu­ver wouldn’t work for a man­ager in New York or Con­necti­cut, since those states say they’re owed taxes on in­come earned while peo­ple resided or worked there, even if the pay­ment of that in­come is de­ferred. Tep­per de­clined to com­ment. But LeVine and fel­low Withers Bergman lawyer Stan­ley Bergman, along with other tax at­tor­neys in the U.S., are telling clients there’s a way to ease the pain—for their chil­dren and fu­ture gen­er­a­tions at least.

It works like this: They can put the money into a char­i­ta­ble lead an­nu­ity trust, or CLAT, and have the trust pur­chase a cus­tom­ized kind of life in­sur­ance pol­icy with an in­vest­ment com­po­nent. The U.S. al­lows the tax­payer to deduct up to 30 per­cent of ad­justed gross in­come for such con­tri­bu­tions. The trust is re­quired to donate only the orig­i­nal de­posit plus a gov­ern­ment-set in­ter­est rate— cur­rently 1.8 per­cent. If the in­vest­ment can earn gains above that amount, those prof­its can grow un­taxed for later dis­tri­bu­tion to heirs.

Scott Sam­bur, a part­ner at Se­ward & Kis­sel in New York, fig­ures the kids of a mid­dle-aged man­ager with $100 mil­lion off­shore would end up pretty happy. As­sum­ing an an­nu­al­ized rate of re­turn on in­vest­ments of 7 per­cent for 28 years, Sam­bur says the man­ager could leave more than $260 mil­lion to his heirs, tax-free. It’s per­fectly le­gal. The rich and their tax ex­perts al­ways man­age to fig­ure some­thing out, says Steven Rosen­thal, a se­nior fel­low at the Ur­ban-Brook­ings Tax Pol­icy Cen­ter. “In this cat-and-mouse game, the ad­vis­ers have the edge,” he says. “The cat is slug­gish, and the mice are nim­ble.” But in this case, at least, the IRS won’t be com­ing away with noth­ing. “You are still pay­ing tax on 70 per­cent,” LeVine says. “No one has come up with the magic bul­let.”

The bot­tom line Money man­agers soon have to rec­og­nize a to­tal of at least $100 bil­lion in off­shore in­come. Good news for char­i­ties and tax lawyers.

Money man­agers “fig­ured that by the time we got to 2017, some­one would have found a way to elim­i­nate all of the tax.” ——Richard LeVine, tax lawyer

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