Tax "deferral" via hedge fund structure

H

heech

Hey guys,

This is something I've been pondering in the back of my mind for some time. I'm sure there's a very good legal reason why this doesn't make sense... but I don't know what that reason is. Thus, thought I'd ask the experts.

As probably most people know, hedge fund managers have the tax advantage (at least for now) of being able to convert their pre-tax fees into capital in the hedge fund... so that they don't end up being taxed until they eventually cash out (and pay long-term cap gains).

Assuming you don't need any funds to live on... why shouldn't a career trader establish something like a hedge fund legal structure, and route all of their trading through the fund? Could you setup "manager fees" to be 100% of all returns... and then have those fees stay in the fund without any taxation?

Again, I'm sure this isn't possible, just looking for an explanation of *where* it all breaks down.

Thanks.
 
Why not just put the money into IRAs, and trade it in futures, whatever? No tax issues until you withdraw it much later. No complexities...
 
Two reasons:

1) can't use leverage in my IRA because of UBIT, not ideal.

2) I already max out my contributions... but I still have 10x funds outside of the IRA, compared to amounts in the IRA.
 
Quote from heech:

Two reasons:

1) can't use leverage in my IRA because of UBIT, not ideal.

Huh? Many other people have no problem trading leveraged within their IRA. I have traded leveraged futures for many years in mine.

2) I already max out my contributions... but I still have 10x funds outside of the IRA, compared to amounts in the IRA.
More...
 
The A holes in congress took our deferral away Jan 1 2009 (republican senator snuck it in to some freedom fighters bill to fund 911 heros or some bs like that). We can still keep deferring for 10yrs if we choose, but frankly none of us are that stupid. HF managers are paying taxes on their deferrals now and making a b line for bahamas, caymans, switzerland and even giving up US passports and citizenship! Taxes are going to 80% in western countries and they are at 0% if you run your fund offshore (and you are not a US citizen). Do this little exercise on a napkin...40 yr old rich hedge fund manager with 100 units of wealth earning 15% compund annual return (assume 3.5% inflation) on his own assets until he dies at 80 = 100(1+.15-.035)^40=7,780...this is a nice number if you are offshore and pay no tax, figure only 50% federal+state+etc paid to a western government (and trust me they will all be higher than this soon) and the equation looks like this 100(1+(.15*.5)-.035)^40=480 oh and then cut it in half for estate taxes and you are left with 240...so i can do the exact same job in a western country (which is nothing but live off interest) and barely double my money or I can end up with close to 80 times my money by simply leaving. To put it in laymans terms i can spend all the money I would have spent on taxes partying like it is the end of the world and live a sick decadent life and still end up better off! Say good bye to all of your wealthy HF manager friends and others...they may not have told you but they are leaving and they are taking all the jobs with them...this is why socialism is difficult...it really only works if you make it illegal to leave...which is what comes next in the west...I'm going to start playing REM now, ha!
 
Interesting vision/math!

So going down that thread of thought... what are the legal restrictions on offshore/foreign entities trading the US markets? How are they taxed, and what securities are they allowed/not allowed to purchase?

Say that I established a corporate entity in Hong Kong, or the island banking centers you listed. Say I funded the entity with my funds, established an account (with Interactive Brokers for example) and traded even while I was residing in the US. I'll just have the corporate entity pay me a nominal salary every year, which I'll pay full taxes on.

... well, when would I get taxed on the capital growing overseas?
 
Well, it sounds like the IRS is on to this:

http://www.investopedia.com/articles/02/020602.asp

"According to the U.S. Internal Revenue Service (IRS), U.S. citizens and residents are now taxed on their worldwide income. As a result, investors who use offshore entities to evade U.S. federal income tax on capital gains can be prosecuted for tax evasion. Therefore, although the lower corporate expenses of offshore companies can translate into better gains for investors, the IRS maintains that U.S. taxpayers are not to be allowed to evade taxes by shifting their individual tax liability to some foreign entity."

Does anyone have more details? I'm not looking to do tax evasion. I do have some worldwide income (overseas savings accounts), which I religiously file every April 15th.

But I'm wondering if I don't cash out from the foreign corporate entity... what tax liability is there? I assume only when I cash out of the foreign entity would there be capital gains.
 
you don't pay 1 penny of tax if you are an offshore investor. so offshore hedge funds dont pay anyone tax (US investors are not allowed). the only thing a US citizen can do to get similar treatment is give up their citizenship. makes tax planning easy really.
 
But I'm wondering if I don't cash out from the foreign corporate entity... what tax liability is there? I assume only when I cash out of the foreign entity would there be capital gains.
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I did a little more research into this. Looks like any such foreign corporate entity (primarily used for investing) would be classified as a passive foreign investment company (PFIC), and all gains/income would be taxed as ordinary income.

From Wikipedia:
http://en.wikipedia.org/wiki/Passive_foreign_investment_company


Looks like short of engaging in a felony, or giving up US residency/citizenship... there really are no other options.

FWIW, I'm actually not a US citizen. I'm a US permanent resident... so the decision to give up residency is easier to make. And if the current administration really goes crazy with the tax haircut, I really will have to pull up stakes and move elsewhere.
 
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