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IRSThe Internal Revenue Service recently proposed rules to stop what it says are abusive maneuvers by private-equity firms. With these rules, the IRS is seeking to limit private-equity executives' practice of reducing their tax bills by reclassifying how their management fees are taxed.

 In turn, it would be harder for firms to convert high-taxed fees into lower-taxed carried interest and take advantage of a 19.6-percentage-point difference in top tax rates. The proposal represents the government's attempt to limit the tax benefits enjoyed by private-equity managers.

Typically, private-equity firms charge their investors a 2-percent fee on their assets and also keep 20 percent of profits, known as carried interest.

Here are two areas where these rules come into play:
• Profits Share. By using waivers, firms can forgo some of their fees and take a bigger share of the profits in addition to the tax benefit of doing so. The rules, aimed at preventing "disguised payments for services," say each case should be decided on the specific facts at hand, with weight given to whether the fund managers bear risk of losing money.
• Capital Pledges. Private equity executives often swap their cut of management fees into investments to satisfy capital pledges they have made to funds managed.

Last modified on Tuesday, 12 January 2016
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