In 2008, President George W. Bush signed into law the Emergency Economic Stabilization Act of 2008 (H.R. 1424), which, among other things, effectively ended the ability of most investment fund managers to defer fees they earned from the offshore funds they managed by virtue of the introduction of Section 457A into the US Internal Revenue Code of 1986, as amended (the “Code”). That legislation, however, grandfathered deferred fees earned for services rendered prior to 2009, provided that such amounts were included in the managers’ income no later than calendar year 2017.1
Eight years later, many managers still have significant amounts of pre-2009 deferred fees owing to them that are payable in the next 12-13 months. Below are certain tax and other considerations of which managers should take note as they plan for the inevitable end of the deferral era.
Pre-2009 fees that have been deferred by managers using the cash method of tax accounting (i.e. almost all such deferred fees) are still subject to Section 409A of the Code. Managers should review their deferral elections and make sure that payment is made at the times provided for in their plans and elections or discuss with their advisers as to whether any modifications are permissible.2 Failure to comply with Section 409A of the Code can lead to an additional tax equal to 20% of the entire amount deferred, as well as additional interest on the amount deferred going back to the tax return due date for the initial year of deferral. Moreover, any deferred fee agreements that are part of a “back-to-back” arrangement need to be operated such that both the payment by the fund to the manager and the related distribution or payment by the manager to its partners and employees comply with Section 409A of the Code.