Trusts that Pass "Carried Interest" to Heirs Gaining Popularity in the Financial Sector

A recent article from the Wall Street Journal’s (WSJ) online edition reported that the new generation of financial whiz-kids, private-equity firm and hedge fund executives in their 30s and 40s, are, for the first time for many of them, planning for their futures, and for their heirs’ future as well. This often involves making their first estate plans, many of which include the establishment of trusts to ensure that their heirs receive a portion of the investments they oversee.

According the article, Boom in Trusts Passing Carried Interest to Heirs, by Arden Dale, “what makes carried interest a popular gifting vehicle is that it typically has a relatively low value initially due to its speculative nature. But, as a hedge fund’s returns grow, so does that value of the carried interest.”

Under the terms of the newly-established trusts, heirs get the right to collect a share of carried interest, a form of compensation that rewards an investment manager for enhancing performance, and could potentially save the heirs a lot in federal gift and estate taxes.

A few of the salient points about carried interest from the article included:

  • Carried interest lets the general partner of a private investment fund share its profits.
  • Often, the general partner is a partnership itself, owned by investment managers, and may contribute 1% to 5% of initial capital for the fund.
  • Carried interest typically equals 20% of a fund’s profits over a set rate of return.
  • Various kinds of trusts can be used for the carried-interest strategy, including grantor-retained annuity trusts and “sale to a defective grantor” trusts.The article goes on to detail some of the pros and cons of the carried-interest strategy. “If it explodes in value, you’ve hit a home run,” said Tye Klooster, an attorney and partner at Katten Muchin Rosenman in Chicago who specializes in carried-interest transfers.However, caution is required when making a carried-interest transfer. The Internal Revenue Code includes various provisions which could trip up the planning, Mr. Klooster pointed out.

    For more information about these carried-interest-based trusts, read the complete WSJ article, Boom in Trusts Passing Carried Interest to Heirs.

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