Since late 2017, hedge fund and private equity executives have created thousands of shell companies in America’s most forgiving tax jurisdiction in what appears to be an effort to game the Republican tax overhaul, according to Bloomberg News.
For example, executives at Starwood Capital Group – an investment firm in Greenwich, Connecticut, that has roughly $56 billion in assets under management – have set up more than 70 limited liability companies in Delaware recently.
The effort is likely driven by an exemption in the carried interest rules established by the tax bill. Under the new rules, investments that produce carried interest – the service fees paid to private equity and hedge fund executives by the companies they manage – must be held for three years in order to benefit from the lower capital gains tax rate. But that time period drops to just one year if the carried interest is paid to a corporation rather than to an individual. One easy way to take advantage of this wrinkle in the rules is to set up LLCs to receive carried interest fees.
According to Bloomberg, that’s exactly what has happened: “Managers are betting that by simply putting their carried interest in a single-member LLC -- and then electing to have it treated as an S corporation -- the profit will qualify for the exemption from the three-year holding period and be taxed at the lower rate. The maneuver by money managers contributed to a 19 percent jump in the number of LLCs incorporated during December in Delaware.”
The party appears to be coming to an end before it really gets going, though. Treasury Secretary Steven Mnuchin, reacting to the Bloomberg story, said Wednesday that the IRS plans to close the carried interest loophole. New guidance is expected within the next two weeks.