Flexing philanthropic muscle can reduce tax bill

Managers of offshore private equity funds can reduce the tax on incentive and management fees due by the end of this year by donating fees or portions of their fund stakes to charity, service providers have said.

Key benefactors would be offshore managers that deferred fees before Internal Revenue Code Section 457A came into effect in 2009. Section 457A stopped deferral of fees and stated managers must distribute any legacy deferrals – and pay the applicable income tax on them – by the end of 2017.

“By donating highly appreciated private equity fund interests to a public charity, including a donor-advised fund, clients can take a full, fair market value income tax deduction for the donation, while also potentially eliminating tax liabilities on fund distributions,” Barbara Benware of Schwab Charitable, a donor-advised fund account provider, said in a client note.

The amount of charitable deduction will vary depending on the type of donation and the organization that receives the gift. In the case of management fees, the transfer would be treated as if the manager received the fee income as compensation for services and later donated cash to charity.

“When a person directs the payment of earned income to another person or entity, this constitutes an assignment of income that is typically disregarded for Federal income tax purposes,” law firm Coblentz Patch Duffy & Bass said in a note.

If a manager is transferring an equity interest in a fund or stock in a portfolio company it will trigger, in most cases, a charitable deduction equal to the asset’s fair market value.

The amount that can be deducted will also depend on the charity to which a donation is made, with different amount applicable depending on the nature of the donation and whether or not the charity is public or private.

“In composing a charitable giving strategy, managers should consider the limitations and consider the various types of public charities, private foundations and donor-advised funds available to accomplish their charitable goals,” Coblentz Patch Duffy & Bass said.

To receive a charitable deduction, managers must get written acknowledgement of the donation, obtain a qualified appraisal of the value of the gift and complete the relevant IRS form that accompanies a tax return.