Wealth Planning with Hedge Fund and Private Equity Fund Interests and Related Section 2701 Issues (Portfolio 875)

Tax Management Portfolio No. 875, Wealth Planning with Hedge Fund and Private Equity Fund Interests and Related Section 2701 Issues, offers an overview of the fundamentals of estate planning with carried interests and a discussion of cutting-edge issues in this area. To view this Portfolio, visit Bloomberg Tax for a free trial.

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Description

Tax Management Portfolio No. 875, Wealth Planning with Hedge Fund and Private Equity Fund Interests and Related Section 2701 Issues, offers an overview of the fundamentals of estate planning with carried interests and a discussion of cutting-edge issues in this area. The Portfolio first provides the reader with a general overview on private equity funds, hedge funds, carried interests, fund structures, and securities law. The Portfolio explores the various estate planning reasons for making transfers of carried interests, and the tax consequences that could result from such transfers. Specifically, the Portfolio closely examines potential pitfalls that could arise under §2701, and details planning approaches to avoid §2701 tax consequences. The Portfolio discusses other transfer tax issues and describes general estate planning techniques in the context of these funds, as well. Finally, the Portfolio addresses special topics in the context of funds, including: buy-sell agreements, deferred compensation planning, international planning considerations, and income tax considerations.

While this Portfolio provides a general overview on private equity funds, hedge funds, and §2701, for more detailed discussions, see 735 T.M., Private Equity Funds (U.S. Income); 736 T.M., Hedge Funds (U.S. Income); and 835 T.M., Transfers of Interests in Family Entities Under Chapter 14: Sections 2701, 2703 and 2704, respectively.

This Portfolio may be cited as Angkatavanich, Stein & Haave, 875-1st T.M., Wealth Planning with Hedge Fund and Private Equity Fund Interests and Related Section 2701 Issues.

Authors

N. Todd Angkatavanich

N. Todd Angkatavanich is a partner at Withers Bergman LLP in the Greenwich, New Haven, and New York offices, and co-heads the Private Client & Tax Group in the firm's United States offices. Todd is a Fellow of the American College of Trust and Estate Counsel and is a member of the Society of Trusts & Estates Practitioners. Todd serves as a member of the Editorial Advisory Board of Trusts & Estates magazine, as well as Chair of the Bloomberg BNA Estates, Gifts and Trusts Advisory Board. Todd has given presentations for a number of organizations, including the Heckerling Institute on Estate Planning, the Federal Tax Institute of New England, the Notre Dame Tax and Estate Planning Institute, and the Duke University Estate Planning Conference. Todd is Co-Chair of the ABA Real Property, Trusts and Estates Section Business Planning Group — Business Investment Entities, Partnerships, LLCs and Corporations Committee. He is a member of the Executive Committee of the Connecticut Bar Association, Estates and Probate Section, and on behalf of the Section he also serves on the Planning Committee for the Federal Tax Institute of New England. He is the 2012 recipient of the award for “Private Client Lawyer of the Year” from Family Office Review. Todd has been included in The Best Lawyers in America® and is also the recipient of the Best Lawyers® 2015 Trusts & Estates “Lawyer of the Year” award for New Haven, Connecticut. He has been rated AV Preeminent® by Martindale-Hubbell® Peer Review Ratings™, is ranked in Chambers HNW, and is listed in Who's Who Legal: Private Client and in Super Lawyers. Todd received his B.A., in Economics, magna cum laude, from Fairleigh Dickinson University, his J.D., Tax Law Honors, from Rutgers University School of Law, Camden, his M.B.A. from Rutgers University Graduate School of Management, and his LL.M. in Taxation, from New York University School of Law.

David A. Stein

David A. Stein is a partner at Withers Bergman LLP in the New York, San Francisco, and New Haven offices, and co-heads the Private Client & Tax Group in the firm's United States offices. His practice involves tax, trusts, and estate planning for wealthy U.S. and international families, with particular emphasis on planning for closely held businesses and investment vehicles. David's work for clients involves a range of matters, from creating tax-efficient wealth transfer structures to addressing income tax issues arising from investments and operating businesses. David received his B.A. at Yale University, cum laude, and his J.D. from New York University School of Law. He is a member of the Connecticut and New York state bar associations and is a registered foreign lawyer in the United Kingdom. He has been rated AV Preeminent® by Martindale-Hubbell® Peer Review Ratings.™ He is ranked in Chambers USA and Chambers HNW, and on the Citywealth Leaders List.

Andrew Haave

Andrew Haave is a partner at Withers Bergman LLP in the London office, serving as the firm's Global IT Partner. His area of expertise includes estate planning, with particular emphasis on high net worth individuals and their families, including the structuring of inter vivos transactions such as grantor trust sale gifts and grantor retained annuity trusts. Andrew received his B.A. in Economics, magna cum laude, from Columbia University, his M.B.A. from Stanford Business School, and his J.D., with high honors, from the University of Connecticut School of Law, where he also received a Certificate in Taxation.

Table of Contents

Detailed Analysis
I. Overview of Fund Structures and Non-Transfer Tax Issues
A. What Is a Fund?
B. What Is Carried Interest?
1. In General
2. Carried Interest in Hedge Funds Versus Private Equity Funds
a. Hedge Funds
b. Private Equity Funds
C. Fund Structures
1. Stand-Alone Funds (with Management Fees Paid to General Partner Entity)
2. Stand-Alone Funds (with Separate Management Entity)
3. Multi-Entity Structures
a. In General
b. Parallel Funds
c. Master-Feeder Funds
D. Management Fee Waiver Mechanism
E. Securities Law
1. What Is a Security?
2. Investment Advisers Act of 1940
3. Securities Act of 1933
4. Investment Company Act of 1940
a. Section 3(c)(1) Exception
b. Section 3(c)(7) Exception
II. Transfers of Carried Interests
A. Benefits of Carried Interest Transfers
B. Valuation Issues
C. Potential Pitfalls of Carried Interest Transfers
III. Deemed Gift Pitfalls Under §2701
A. Introduction
B. What Does §2701 Do?
C. Why Does §2701 Exist?
1. Anti-Abuse Context
2. Planning Prior to Enactment of §2701
3. Repealed §2036(c)
D. How Does §2701 Work?
1. Transfer
2. Equity Interest
a. Indirect Interests and Ownership Attribution Rules
(1) Entity Attribution Rules
(2) Trust Attribution Rules
(a) Basic Trust Rules
(b) Grantor Trust Attribution Rule
(c) Multiple Attribution Rules
b. Other Financial Arrangements Potentially Treated as Equity Interests
(1) Compensatory Arrangements
(a) Management Fees
(b) Performance Fees
(2) Options and Other Derivatives
(3) Debt
3. Member of the Family and Applicable Family Member
a. Applicable Family Member
b. Member of the Family
c. Implications of the Windsor Decision
4. Applicable Retained Interest
a. Extraordinary Payment Rights
b. Distribution Rights
(1) Funds Generally
(a) Hedge Funds
(b) Private Equity Funds
(2) Control Requirement
(a) In General
(b) Sidestepping Control
(3) Qualified Payment Rights
(a) In General
(b) “Lower Of” Rule
(c) Election for Qualified Payment Right Treatment
c. Rights that Are Neither Extraordinary Payment Rights nor Distribution Rights
E. Circumstances in Which §2701 Does Not Apply
1. Same Class Exception
2. Market Quotations
3. Proportionate Transfers (“Vertical Slice” Exception)
a. In General
b. Achieving Verticality
(1) In General
(2) Holding Entity to Achieve Verticality
(3) Limitations on Achieving Verticality
F. Other §2701 Topics
1. Minimum Value of Junior Equity Interest
2. Consequences of §2701 — Alternative Analysis
3. Does §2701 Cause the Entire Fund Retained Interest to Be Valued at Zero Under the Subtraction Method?
4. Potential Avoidance of §2701 Through Gifts of Master Fund
G. Section 2701 Exceptions: Planning Approaches Other than the Vertical Slice (“Nonvertical” Approaches)
1. Qualified Payment Right Holding Entity Approach
2. Mandatory Payment Right Holding Entity Approach
3. Holding Entity with Debt Approach
4. Treatment of These Nonvertical Approaches
5. Other Nonvertical Approaches
a. Parallel Transfers to Completed Gift and Incomplete Gift Trusts
b. Completed Gift to Trust with Limited Power of Appointment
c. Derivatives
IV. Transfer Tax Issues Other than §2701
A. Preferred Partnerships — Estate Tax Considerations and §2036 Generally
B. Section 2036(a) Considerations for the Vertical Slice Holding Entity Approach
1. Section 2036(a)(1) Inclusion and the “Bad Fact” FLPs
2. Section 2036(a)(2) Inclusion
a. Estate of Strangi v. Commissioner
b. Estate of Turner v. Commissioner
c. Estate of Powell v. Commissioner
3. The Bona Fide Sale Exception
4. Estate Tax Marital Deduction Mismatch Issues
C. Valuation of the Preferred Coupon
D. Valuation Challenges Generally
1. “Cushion” Approach
2. Price Adjustment Approach
3. Formula Allocation Provision Approach
4. Formula Definition Approach
5. Cash Funding with Subsequent Swap Approach
E. Additional Considerations — Incomplete Gifts and Vesting Issues
1. Overview
2. Considerations for the Noncontrolling Principal
a. The Question of Vesting
b. Distinguishing Unvested Stock Options from Unvested Carry Interests
c. Income Tax Treatment of Unvested Partnership Profits Interests
3. Considerations for the Controlling Principal
a. Incomplete Gift Due to Retained Discretionary Powers
b. Additional Gift Due to Exercise of Retained Powers
c. Are Incomplete Gift and Additional Gift Concerns Mitigated by the Doctrine of Independent Significance?
d. Planning Approach for Founding Principals
(1) Fixing the Gifted Interest
(2) Reducing and Increasing Interests Proportionately
V. Estate Planning Techniques for Transfers of Fund Interests
A. Introduction
B. Multi-Generational Trusts
C. Leveraged Transfer Planning Techniques
1. Gift and Sale to Intentionally Defective Grantor Trust
2. Grantor Retained Annuity Trusts
3. Preferred Freeze Partnership
VI. Buy-Sell Agreements and Succession Planning
A. Coordination with Transfer Planning Generally
B. Funding and Maintaining the Buy-Sell Agreement
C. Section 2703 Transfer Tax Special Valuation Rules
VII. Deferred Compensation Planning
A. Section 457A
B. Charitable Lead Annuity Trusts
C. Private Placement Life Insurance
VIII. International Planning for the Global Fund Principal
A. Introduction
B. Expatriation
C. Planning Opportunities with Non-U.S. Family Members
1. Creating a Foreign Grantor Trust
2. Acquisition of Fund Interests by Foreign Grantor Trust
3. Section 2104(b) Estate Tax Issues
IX. Income Tax Considerations
A. Section 83
1. Overview
2. Application to Funds
3. Rev. Proc. 93-27 and Valuation of a Profits Interest
4. Profits Interests and Vesting
5. Effect of Rev. Proc. 93-27 and Rev. Proc. 2001-43 and §83(b) Protective Elections
6. Additional Considerations
a. Income Tax and Transfer Tax Valuations
b. Sale Within Two Years
7. 2005 Proposed Regulations
B. Net Investment Income Tax (§1411)

Working Papers

Table of Worksheets
Worksheet 1 Diagrams of Hedge Fund and Private Equity Fund Structures
Worksheet 2 Diagrams of Vertical Slice Wealth Planning with Hedge Funds and Private Equity Funds
Worksheet 3 Diagrams of Nonvertical Slice Wealth Planning with Hedge Funds and Private Equity Funds