Phantom Carried Interest (i.e. Promote) Tax Structuring
Our firm provides phantom carried interest on investments. In other words, the payment is not from a capital account and taxed at capital gains tax rates, it is effectively a fee and is taxed at ordinary income rates. Each investment is uncrossed and provides a "crystallized" promote, determining the amount of the carry. We can also receive liquidity over time intervals at our election.
Since phantom carry is taxed at ordinary income rates (as opposed to the long-term capital gains rate for traditional carry), I'm exploring any creative tax strategies to help minimize the tax burden.
A few ideas I've considered:
- Defined Benefit Plan
- Solo 401(k) Profit Sharing (with income earned through an LLC or C-Corp)
Has anyone implemented other strategies in similar situations? Would love to hear more suggestions.
Based on the most helpful WSO content, here are some strategies and insights related to minimizing the tax burden on phantom carried interest:
Defined Benefit Plan:
Solo 401(k) Profit Sharing:
Additional strategies to consider: - Deferred Compensation Plans: These plans allow you to defer a portion of your income to a future date, potentially when you are in a lower tax bracket. - Health Savings Account (HSA): If you have a high-deductible health plan, contributing to an HSA can provide tax benefits. Contributions are tax-deductible, and withdrawals for qualified medical expenses are tax-free. - Real Estate Investments: Investing in real estate can provide depreciation deductions, which can offset other income. - Charitable Contributions: Donating to charity can provide significant tax deductions, reducing your taxable income.
For more detailed advice, consulting with a tax professional who specializes in high-income earners and investment income is recommended.
Sources: The insanity of the US tax code: Bad Laws and Predictable Consequences, Some Very Basic RE Questions, TRUMP TAX PLAN, 10% Tax Cuts Coming Soon?, PE Comp Question - VP / Principal Level
I’m exposed to phantom income on a daily basis since one of our MF assets in South Florida (75-unit, class A multifamily rental) is structured in a generation skipping trust.
We mitigate the tax bite however based on the cost seg we ran on the $50M repositioning we just completed this year.
Maybe “undergoing an extensive capital improvement plan just so you can take bonus depreciation” isn’t necessarily a viable strategy but maybe it leads you somewhere.
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