One strategy that wealth advisors frequently use to reduce taxes for hedge fund investors is the offshore fund. Although U.S. individuals are not permitted to invest directly offshore, they may do so using an offshore trust or by purchasing offshore life insurance. Furthermore, many tax-free and tax deferred U.S. entities can invest in offshore funds. Some of these entities include endowments, retirement plans, IRAs and foundations. The solution for the U.S. investor desiring both hedge fund exposure and tax deferral is to invest in an offshore entity via these vehicles.
As the money manager, you need to ensure that your offshore fund elects to defer management and incentive fees. This provision will allow you to defer order fees for a predetermined period and allow them to grow along with the fund on a tax-deferred basis. The election to defer has nothing to do with the fact that the entity is offshore, but rather that it is not a flow-through vehicle. If it was a flow-through vehicle, the fees would not be reflected as expenses for tax purposes, and the investors would be paying tax on profits associated with these fees (particularly incentive fees).
Whether you use this tax structure for your clients, or have a proprietary strategy that helps mitigate the tax burden, SS&C's hedge fund software, AdvisorWare, can handle your investment processing and tax accounting needs. As always, you should consult with your professional tax advisor when making elections.