Fund managers are restructuring their management companies after the US tax authority, the Internal Revenue Service (IRS), said that all fees paid to management companies formed as limited liability companies (LLC) are subject to social security taxes last month.
Under the new IRS guidance LLC’s, a typical structure in the private funds industry, receiving fees will be subject to net earnings from self-employment and net investment income taxes.
Previously these taxes were only paid once the cash was in the hands of individuals working for the management company meaning any fee income that was not paid out to fund managers, and left as a reserve in the LLC, was not taxed.
However, tax experts said that fund managers can get around this problem by restructuring their management companies as in the tax code there is an exemption for limited partnerships.
“If the management company is formed as an LP instead of an LLC, fund managers should be able to avoid the social security taxes tax on the fee income that remains in the management company after the payment of salaries,” said Mark Leeds, tax partner at law firm Mayer Brown.
“I helped clients undertake restructurings myself and I know others have been restructuring management companies from LLC to LPs in order to lessen the impact of the tax.”
Leeds added that restructuring is often not a complex or time-consuming task for fund managers as in many states, including Delaware where most private fund management companies are organized, have a provision that allows for the conversion of an LLC to an LP, or vice versa, just by filing a form with the state.