Minimizing IRS Scrutiny of Private Equity Management Fee Waivers: Structuring Defensible Waiver Agreements

The IRS continues to address potential abuses of fees in private equity by conducting a series of audits focusing on fee waiver arrangements. Attorneys and advisers must recognize what pitfalls to avoid when advising and crafting fee waiver arrangements to minimize potential adverse tax liability.

The IRS applies a facts-and-circumstances test to determine whether a fee waiver arrangement should be treated as payment for services. The critical factor is whether the waiver lacks significant risk, and the regulations list a number of factors relevant to whether a fee waiver arrangement should be recharacterized as ordinary income.

Tax counsel to private equity funds should consider whether existing fee waiver arrangements are likely to be challenged on audit, which may lead to reclassification of profits interest as ordinary income.

Listen as our experienced panel provides practical guidance on the IRS' position on management fee waivers, including best practices for structuring waivers that maximize the chance of withstanding IRS scrutiny.