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With the enactment of Internal Revenue Code Section 457A in 2008, offshore hedge fund fee deferral programs were effectively ended. Functioning as nonqualified deferred compensation plans, these programs enabled hedge fund managers to defer fee income (or carried interest characterized as fees) using offshore vehicles. By the end of 2017, hedge fund managers with such offshore plans will need to repatriate these funds, often creating significant income tax issues. However, for those hedge fund managers who are philanthropic, the repatriation mandated by Section 457A can be a tremendous opportunity for high-impact charitable giving.
Up until 2008, it was common planning practice for hedge fund managers to fund offshore deferred compensation plans using fees generated from offshore investment funds. This planning allowed these offshore deferred compensation plans to accumulate without being subjected to taxation in the United States.
Section 457A approached the offshore fee deferral issue in two ways. First, looking forward from January 1, 2009, Section 457A provided that such deferred compensation shall be includible in gross income when there is no substantial risk of forfeiture of the rights to such compensation. Practically speaking, this provision removed the possibility of offshore deferral of income for services performed going forward from January 1, 2009.
The second element of Section 457A addressed funds that had already accumulated in such plans for services performed before January 1, 2009. A sunset provision was structured so that all such deferred compensation must be repatriated on or before December 31, 2017. For many hedge fund managers, this will cause a dramatically higher income in 2017. This required repatriation by the end of 2017 is the element that is driving the present planning for many in the hedge fund community.
While Section 457A will require the repatriation by hedge fund managers of significant dollar amounts, it is also expected that this repatriation will encourage significant charitable giving. Many hedge fund managers already provide critical support to numerous charities—both large and small—but with the higher income expected due to repatriation, these charities could see that support further expanded. This would be a terrific byproduct of Section 457A.
Though the income experienced by some hedge fund managers may be dramatically higher, charitable planning strategies their advisors recommend are expected to remain quite simple.
In significant income years, philanthropic managers often complement their high income with a substantial charitable contribution, allowing them to support their favorite charities while taking advantage of a charitable income tax deduction. With potentially outsized income in 2017 due to repatriation, it is expected that many hedge fund managers will see this as an opportunity to be even more charitable.