One major tax planning strategy for hedge funds is to use 澳洲幸运5官方开奖结果体彩网:carried interest from a 澳洲幸运5官方开奖结果体彩网:hedge fund to the general partners for performance fees paid to hedge fund managers. A newer tax strategy many funds are using is to enter the 澳洲幸运5官方开奖结果体彩网:reinsurance business with a company based in Bermuda. These two methods allow hedge funds to reduce their tax liabilities substantially. In this article, we look aꦛt how both strategies work, along with how hedge funds are compensated.

What Is a Hedge Fund?

A 澳洲幸运5官方开奖结果体彩网:hedge fund is an alternative investment class that try to earn active returns for their investors by taking advantage of different market opportunities. They are often set up as private investment partnerships. Because of their large minimum investment requirements, they are usually cut off to the average investor. Instead, they cater to accredited investors—those who have a high 澳洲幸运5官方开奖结果体彩网:net worth, high income, and whose asset size is fairly large. Hedge funds are generally considered illiqui𝓰d, which means investors need to have a long-term horizon and can't capitalize on short-term gains.

Compensation Structures

Most hedge funds are managed under the 澳洲幸运5官方开奖结果体彩网:two and twenty compensation structure or some other variation. This structure normally comprises of a management fee and a performance fee. These fees depend on and can🉐 vary between funds.

The hedge fund manager charges a flat 2% fee 澳洲幸运5官方开奖结果体彩网:management fee based on the value of the t🐻otal amount of assets in the fund. These management fees cover the operating costs for the fund including trading costs.

The 澳洲幸运5官方开奖结果体彩网:performance fee is a percentage of the profits realized under the hedge fund's management. The most common performance fee is 20% of profits. This number may be higher or lower depending on the individual fund. Many funds also utilize 澳洲幸运5官方开奖结果体彩网:high-water marks to ensure the mana꧅ger is not paid ꦓfor subpar performance.

Carried Interest

Many hedge funds are structured to take advantage of carried interest. Under this structure, a fund is treated as a partnership. The founders and fund managers are considered general partners, while the investors are referred to as 澳洲幸运5官方开奖结果体彩网:limited partners. The founders also own the management company that runs the hedge fund. The managers earn the 20% performance fee of the carried interest as the 澳洲幸运5官方开奖结果体彩网:general partner of the fund.

Hedge fund managers are compensated with this carried interest. The income they receive from the fund is taxed as a return on investment as opposed to a salary or compensation for services rendered. The 澳洲幸运5官方开奖结果体彩网:incentive fee is taxed at the long-term 澳洲幸运5官方开奖结果体彩网:capital gains rate of 23.8%—20% on net capital gains and another 3.8% for the net income tax on investments—as opposed to ordinary income tax rates, where the top rate is 37%. This represents significant ta🧔x savin🍷gs for hedge fund managers.

This business arrangement has its critics, who say that the structure is a loophole that allows hedge funds to avoid paying taxes. The 澳洲幸运5官方开奖结果体彩网:Tax Cuts and Jobs Act made some changes to the carried interest rule. Under the law, funds must hold assets for more than three years for gains to be considered long-term. Any gains held for less than three years are considered to be short-term, and are taxed at a rate of 40.8%. But this change rarely applies to most hedge funds, which generally hold assets for more than꧂ five years.

Bermuda Reinsurance Business

Many prominent hedge funds use the reinsurance businesses in Bermuda to reduce their tax liabilities. Bermuda does not charge a corporate income tax, so hedge funds set up their own 澳洲幸运5官方开奖结果体彩网:reinsurance companies in Bermuda. Remember, a reinsurance company is a type of insurer that provides protection to insurance com♏panies. They handle risks that are conside🌠red to be too large for insurance companies to take on on their own. Therefore, insurance companies can share the risk with reinsurers, and keep less capital on the books to cover any potential losses.

Hedge funds send money to the reinsurance companies in Bermuda. These reinsurers, in turn, invest those funds back into the hedge funds. Any profits from the hedge funds go to the reinsurers in Bermuda, where they owe no corporate income tax. The profits from the hedge fund investments grow without any 澳洲幸运5官方开奖结果体彩网:tax liability. Capital gains taxes are only owed once the investors sell their stakes in the reinsurers.

The business in Bermuda must be an insurance business. Any other type of business would likely incur penalties from the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS) in the United States for 𒈔澳洲幸运5官方开奖结果体彩网:passive forei𓆉gn investment companies. The IRS defines insurance as an active business.

To qualify as an active business🥀, the reinsurance company cannot have a pool of capital much larger than what it needs to back the insurance it sells. Although many reinsurance companies do engage in business, it appears to be fairly minor when compared to the pool of money from the hedge fund used to form the companies.