How Private Equity Managers Avoid Taxes On Compensation

Here is a very brilliant paper that exposes the aggressive technique of “Fee Conversion” used by private equity managers to convert ordinary income into deferred capital gains.

Article Abstract & Introduction (Via Conglomerate Blog)

In contrast, a little-known technique utilized by private equity managers to convert the character of their remaining compensation income is extremely aggressive and subject to serious challenge by the IRS. Private equity managers regularly attempt to convert their fixed annual two percent management fees into additional carried interest through so-called “management fee conversions.” The tax result, if this technique is successful, is the conversion of current ordinary income into deferred capital gains.

Despite the recent spotlight on the taxation of private equity management compensation, surprisingly little attention has been paid to this particular tax minimization strategy. This article attempts to fill that void. Its purpose is twofold. First, it will describe the mechanics of management fee conversions, which are pervasive within the private equity community but not widely appreciated or understood outside of it. Second, it will discuss the tax issues stemming from management fee conversions, focusing on the IRS arguments that could be made to disallow their intended tax results.

Click here to download the paper on private equity compensation and taxes

About Miguel Barbosa

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08. November 2008 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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