Minimizing IRS Scrutiny of Private Equity Management Fee Waivers: Structuring Defensible Waiver Agreements

The IRS proposed regulations in 2015 to address potential abuses in the practice, and the IRS has conducted a series of audits focusing on fee waiver arrangements. It is unclear if or when the regulations will be finalized, but current tax reform proposals would affect many current and future fee waiver arrangements.

The proposed regulations apply a facts-and-circumstances test to determine whether a fee waiver arrangement should be treated as payment for services. The critical factor is whether the waiver lacks “significant entrepreneurial risk,” and the proposed regulations list a number of factors relevant to whether a fee waiver arrangement should be recharacterized as ordinary income.

Tax counsel to private equity funds should consider whether existing fee waiver arrangements are likely to be challenged on audit, which may lead to reclassification of profits interest as ordinary income. The implications of tax reform should also be considered.

Listen as our experienced panel provides practical guidance on the IRS’ position on management fee waivers, including best practices for structuring waivers that maximize the chance of withstanding IRS scrutiny.

1. Common management fee waiver structures
2. Overview of the proposed regulations
   1. Entrepreneurial risk
   2. Other factors including gross vs. net income allocations, capped allocations and hard-wired arrangements
3. 2017 audit activity focused on fee waiver arrangements
4. Potential effects of reclassification (application of Section 409A or 4547A to disguised fees)
5. Strategies for revising fee waiver arrangements
6. Implications of tax reform

The panel will review these and other key issues:

• How are management fee waivers typically structured and what are the tax risks inherent in these structures?
• What conditions on the general partner’s receipt of the special allocation could make the arrangement more defensible and how does the timing of the election impact the risks?
• What are the key factors identified by the proposed regulations for analyzing whether a fee waiver arrangement will withstand IRS scrutiny?
• How would tax reform affect fee waiver arrangements?

Learning Objectives

After completing this course, you will be able to:

• Identify terms in management fee waiver arrangements that may not meet IRS entrepreneurial risk requirements
• Understand the implications of recharacterization of a fee waiver arrangement
• Discern structures that are more likely to withstand IRS scrutiny

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite: Three years+ business or public firm experience at mid-level within the organization, preparing complex partnership agreements and income tax forms and schedules for partnerships and pass-throughs; supervisory authority over other attorneys or accountants. Knowledge and understanding of private equity fund partnership structures, carried interest compensation, and profits interest. Familiarity with management fee waiver structures, economic risk rules and audit processes.

Strafford Publications, Inc. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of Accountancy have final authority on the acceptance of individual courses for CPE Credits. Complaints regarding registered sponsons may be submitted to NASBA through its website: www.nasbaregistry.org.

IRS Approved Provider

Strafford is an IRS-approved continuing education provider offering certified courses for Enrolled Agents (EA) and Tax Return Preparers (RTRP).