United States

IRS confirms management fee waiver audits have begun

TAX ALERT  | 

In July 2015, responding primarily to perceived abuses of management fee waivers in the private equity industry, the IRS proposed Reg. section 1.707-2, attacking so-called ‘disguised payments for services’ from a partnership to its partners (see prior coverage, IRS issues proposed regulations on disguised payments for services). Although not properly effective until finalized, the IRS indicated in the preamble to the proposed regulations that it believes the regulations reflect existing legislative intent, suggesting that it would use the included principles to attack fee waiver transactions even before finalization. In comments to the Federal Bar Association, and reported by Bloomberg BNA, Clifford Warren of the IRS’s Office of Chief Counsel confirmed that field examiners are looking at fee waivers in active examinations.

Previous reporting by Bloomberg BNA had indicated that at least one private equity fund had informed its limited partners that the IRS was looking into its fee waiver arrangements, leading to speculation that these examinations might be more widespread. Nevertheless, Mr. Warren’s comments appears to be the first on the records statement by an IRS official that fee waiver arrangements are actively being challenged via examination.

While it is generally late to alter prior fee waivers, private equity managers would do well to heed Mr. Warren’s advice and exercise caution before entering into any further fee waiver arrangements. While the IRS does not yet have the full force of finalized regulations on its side (any may not for some time, due to the Trump Administration’s ongoing freeze on regulatory activity), managers can expect the IRS to vigorously contest fee waivers in examination, setting up lengthy appeals and possible litigation, all with no guarantee of a favorable resolution.

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