2008 Tax Planning and Compliance Update

Agenda

• Year-End Tax Planning• Deferred Compensation Planning and

Restructuring• FIN 48 • Legislative Updates and Other Current

Developments

Year-End Tax Planning

Tax Efficient Investing in Hedge Funds/Private Equity

• Investors are asking managers about tax efficiency: How are they employing tax efficient trading

strategies? Do they know after-tax return of fund? Can they discuss specific trading strategies or

techniques that create tax efficiency?

Tax planning should be part of the daily trading – not just a year-end review.

Tax Efficient Investing in Hedge Funds/Private Equity

• Is the fund an investor or trader? Investor fund level expenses are IRC 212 Investment

expenses subject to limitations to individuals and trusts.

• Consider Investing in Offshore Fund (PFIC) and make Qualifying Electing Fund (“QEF”) election. Result is taxation similar to mutual fund with some

additional US tax return reporting Preserve LTCG pass-through from fund Preserve tax deferral of unrealized gains Fully deduct fund level expenses even if investor fund LTCG treatment on redemption/sale of owned > 12 mo

Tax Efficient Investing in Hedge Funds/Private Equity

• Structured Products/Derivatives Total Return Swaps

IRS Rules – Mark to Market – Ordinary Income “Bullet Swaps” – No payments made/received during term of swap. Result is capital gain. New Swap arrangements – Contract for Differences

Warrants Call Options Hedge Fund Index – CFSB Tremont, HFR, MSCI

(Morgan), S&P, Dow Jones(consider investing in index through derivative)

BEWARE OF CONSTRUCTIVE OWNERSHIP RULES

Tax Efficient Trading Strategies

• Holding Period Strategies LTCG – track days left to LTCG Qualifying Dividends – must be long 61 days – not

hedged Short Dividends Paid – In Lieu – 46 day short to treat

as investment interest expenses versus STCG

Tax Efficient Trading Strategies

• High Cost Tax Lot• Consider Futures versus index funds (SPDR,

QQQ) or options. Futures receive 60/40 treatment (effective 23% tax rate) regardless of holding period.

• “Bullet” Swaps (no payments made or received during term of swap)- avoids mark to market treatment- obtain long-term capital gain (held > year)- may be effective for long and short positions

Tax Efficient Trading Strategies

• Tax Loss Harvesting Sell loss positions Avoid wash sale treatment

• Avoid Wash Sale Techniques (wash sale is sale of stock or securities at loss and within 30 days before or 30 days after sale a purchase of “substantially identical stock or securities has occurred). Wash sale rules apply to long and short positions. Doubling-up forward conversion Sell loss security – purchase basket swap Sell loss security – purchase out of money call

Tax Efficient Trading Strategies• Hedging Strategies

Short against-box –utilize constructive sale exemption

(cover short position within 30 days of year-end and maintain long position unhedged (“naked”) for 60 days beginning on date short position is covered).

“Straddle Rules” – offsetting positions – example purchase a put option on long stock owned.

Result: 1) loss on put options is deferred until sale of long stock, and 2) holding period of long position is suspended

Qualified Cover Calls (avoids Straddle rules)

Tax Efficient Trading Strategies

Overall goal of tax efficient trading is to maximize the after tax returns of the investment without impacting the overall investment strategy of the fund.

Year-end tax planning is important in this goal, but often is to late to a make significant impact in tax results that may be made by employing continual tax planning.

Deferred Compensation

• Section 457A included in Emergency Economic Stabilization Act

• Effectively eliminates the ability of hedge fund managers to defer compensation from offshore funds

• Effective for compensation related to post-2008 services

• Transition rules• Restructuring considerations

FIN 48 – Accounting for Uncertainty in Income taxes

• On October 15, 2008 FASB voted to defer for ALL private entities

• One year deferral• Domestic and Offshore private investment funds

should benefit• FASB Staff Position (FSP) will have details• Next steps for fund managers and CFOs

Legislative Update

• Tax policy implications of Obama presidency: carried interests, tax rates

• Update on 2008 legislative proposals affecting industry: sec. 1256, UBTI

• Paid Preparer Rules

Other Current Developments

• Tax consequences related to changing prime brokers and Lehman bankruptcy

• Short sale tax rules• NYS proposal to treat credit default swaps as

insurance – tax implications• Trader Tax Court case – Holsinger• Tax issues related to redemptions