In 2008, Congress eliminated a common mechanism used by hedge fund managers that enabled them to defer the receipt of incentive or management fees earned. Under IRC § 457A, which was effective for fees earned for services rendered on or after Jan. 1, 2009, hedge fund managers would be limited in their ability to defer those fees. Before IRC § 457A, the management company was able to defer the receipt of the incentive or management fees (per the deferral agreements) that were charged to the offshore fund. Those fees were able to grow, tax deferred, for up to 10 years. Because the management company would elect to be a cash-basis taxpayer, the management company, and therefore its owners, did not have to recognize that taxable income until the cash was received by the management company. But under the new rules, the ability to defer fees earned after Jan. 1, 2009, was limited. So any fees earned and deferred before Jan. 1, 2009, would have to be recognized for tax purposes by 2017.
We’ve highlighted the issue in a couple places over the years (click here for one article, and here for another), wondering how states would react to all this.
Well, 2017 is here. What are states saying? Interestingly, not much. Connecticut actually passed a law back in 2014 addressing the allocation of deferred income received by nonresidents from offshore hedge funds (See Act 14-155). And just last week, the New Jersey Division of Taxation issued guidance on the issue. Under the New Jersey guidance, hedge fund managers must source compensation deferred under IRC Section 457A to New Jersey if it was attributable to New Jersey at the time it was earned and deferred. But for most other states, including New York, cue the sound of crickets chirping. We haven’t heard much of anything. Like many issues on the state tax world, the fireworks may start later, in tax audits, after tax returns have been filed.
