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New Hedge-Fund Tax Dodge Triggers Wild Rush Back Into Delaware
Firms set up LLCs in plan to avoid carried-interest change
Congress may have stumbled in narrowing loophole for managers
Excerpt
Originally published February 14, 2018 at 4:00am EST
Wall Street’s fast-money crowd is returning to well-trodden ground to elude Trump-era tax laws: Delaware.
Since late 2017, hedge fund managers have created numerous shell companies in the First State, corporate America’s favorite tax jurisdiction. These limited liability companies share a common goal: dodging new tax rules for carried-interest profits through a bit of deft legal paperwork.
Big names appear to be embracing the maneuver, which requires setting up LLCs for managers entitled to share carried-interest payouts. Four LLCs have been created under the name of Elliott Management Corp., the hedge-fund giant run by Paul Singer. More than 70 have been established under the names of executives at Starwood Capital Group Management, the private-equity shop headed by Barry Sternlicht.
President Donald Trump turned carried interest into a rallying cry during his populist presidential campaign, declaring that “hedge fund guys are getting away with murder.” Critics from billionaire Warren Buffett on down essentially agree, saying carried interest is a fee-for-service and should be taxed at the individual rate that today tops out at 37 percent. But money managers are eligible to pay a rate of about 20 percent, having successfully argued for years that carried interest, or their portion of investment returns, is a capital gain. […]
Watch: Article cited by Sen. Wyden
This clip is taken from a C-Span Video of Treasury Secretary Steve Mnuchin appearing before the Senate Finance Committee on February 14, 2018. In the clip, Senator Ron Wyden (D-Oregon) cites my article that Bloomberg published earlier that same morning, describing a tax dodge that hedge fund managers planned to use to circumvent new limits on the favorable tax treatment accorded to carried interest.
Wyden cites the article in stating that hedge funds were already finding a way to get around the new carried interest rule, the cornerstone of the Trump Administration’s populist promise to crack down on favorable tax treatment for Wall Street fund managers. Mnuchin responds to Wyden’s criticism by saying that he convened a meeting earlier that morning with members of the IRS and Treasury after reading the article. Mnuchin then says that the two agencies plan to issue guidance stating that fund managers won’t be allowed to use the tax strategy to gain favorable capital gains treatment on carried interest.
The Story Behind the Story
As part of my beat at Bloomberg, I would go through monthly lists of newly incorporated companies, limited liability companies and partnerships in Delaware. In December 2017, I noticed that there had been an unusually large number of LLCs formed during the month.
President Donald Trump had signed the Tax Cuts and Jobs Act of 2017 that December. The new law subjected the carried interest and performance fees earned by hedge fund and private equity firms to higher taxes if the underlying investments that generated these fees were held for less than three years.
I spoke to tax lawyers who told me that the principals at money management firms were forming their own personal limited liability companies to take advantage of a loophole that Congress had inadvertently created in a rush to write and adopt the new legislation. I realized that many of the new LLCs seemed to bear the initials of top executives at various hedge fund and private equity funds. I then called these firms to confirm that their top people set up their own LLCs to take advantage of the loophole.
I published a story on February 14, 2018, describing the strategy and identifying firms who were using it. That same day, Steve Mnuchin, the US Treasury Secretary at the time, was appearing before the Senate Finance Committee. Ron Wyden, the ranking Democrat on the Senate Finance Committee, cited my story to Mnuchin during the hearing, stating that it showed the legislation was flawed. Mnuchin then said to Wyden that he had seen my story that morning and that the Treasury was going to propose rules to close the loophole. The Treasury did eventually propose and adopt rules that corrected the ambiguity in the original tax legislation.