IRS Proposed Rules On Private Equity Management Fee Waivers

Last week, the Internal Revenue Service issued proposed regulations that provide guidance to partnerships and their partners regarding when an arrangement will be treated as a "disguised payment" for services (REG-115452-14). One arrangement covered by the proposed rules concerns "fee waiver" arrangements in private equity funds. These arrangements are increasingly common, but their tax treatment is receiving more scrutiny. The proposed rules are the first official statement by the IRS about how it views these arrangements. If they are adopted, fund managers may see a significant change in the tax treatment related to such fee waivers.

The proposed regulations should be viewed in the following context. Fund managers typically charge a 2% management fee on assets managed and receive 20% of any profits of the fund (a "carried interest" or "carry"). The taxation of a carried interest has been consistent for many years. The holder of a profits interest in a partnership