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”
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 IRS-approved 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.”
Katherine Burton and Margaret Collins
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