Management fee waivers have garnered considerable scrutiny from the Internal Revenue Service (IRS) and the New York Attorney General. However, the IRS recently indicated it likely will not take a formal position regarding the waivers but will reserve the right to examine a waiver structure during an audit. (Watch the video below.)
The typical management fee waiver permits the general partner (GP) of a private investment fund to forgo management fees in exchange for a special profits allocation in the fund. If structured properly, the foregone management fee is not recognized in the year it otherwise would be payable, but instead the GP recognizes income when profits are ultimately allocated to it. Also, under current law, the profits allocated to the GP typically are taxable as long-term capital gain, and the deemed contribution satisfies a portion of the GP's capital commitment to the fund with pre-tax dollars.