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Current Environment Provides Perfect Moment for Gifting Carried Interests

A carried interest in a recently formed private equity or hedge fund is one of the most favorable assets for shifting wealth to future generations at little, or perhaps zero, gift tax cost.

Here’s why:
The valuation analysis of a carried interest for gift tax purposes should address the likelihood of the fund portfolio producing a return sufficient to exceed the investment hurdle rate.  Many newly formed funds, especially in this economy, have shown little growth in portfolio investments and might, therefore, support a low valuation.  The lower the valuation the lower the gift tax.

Discounts for lack of control and lack of marketability might also apply.  These could decrease the valuation further and reduce gift taxes even more.

Pending legislation blurring the waters on tax treatment of carried interests.
In December, the House of Representatives voted to treat a private equity principal’s carried interest as regular salary rather than capital gains.  The issue now moves to the Senate, which reconvened on January 20, 2010, though it is not yet determined when they will vote on this ruling.

If the ruling passes, the tax savings for transferring a carried interest to the next generation could potentially be even more compelling.  As most fund principals pay current income at the highest tax bracket (which many tax professionals expect to climb even higher), transferring the current income to those in a lower marginal tax bracket would result in further tax savings.  However, Congress could decide to treat a carried interest like deferred income, which could eliminate the possibility of transferring the carried interest in an estate plan.  This possibility underscores the need to act in the near term to take advantage of the current environment. 

Getting started:
Regardless of the capital gain vs. ordinary income tax result from pending legislation, the current combination of low valuations and favorable gift tax implications is an opportunity worth exploring for fund principals looking to gift wealth to the next generation.

We suggest you consult your estate planning professional to determine the strategy that best fits your needs.

If you are interested in learning how we can help you use carried interest to minimize gift taxes–or the status of relevant legislation–contact your Blackman Kallick representative or Rich Lies – Corporate Finance Consulting, at (312) 980-2922 or rlies@BlackmanKallick.com.
 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.