Hedge Funds and Taxes

Hedge funds provide a vehicle to pool private capital for investment in stocks, securities and financial derivatives.  While hedge funds take on many different structures—including master-feeder, parallel, or fund-of-funds structures—they share many similar tax considerations.

Hedge fund tax issues include entity classification, tax allocations, the taxation of carried interests, swap taxation, withholding, and numerous other issues.  In this Insight post, we discuss the typical hedge fund structure and usual players, as well as several common tax issues.

Typical Hedge Fund Structures

Most hedge funds use one of the following organizational structures: 1) a single entity fund, 2) a master-feeder fund, 3) a parallel fund, or 4) a fund of funds.

A typical hedge fund structure involves an entity formed as a partnership for U.S. federal tax purposes acting as an investment manager with a separate entity functioning as a general partner.  The investment or fund manager is generally compensated through a management fee, typically tied to a percentage of the fund’s net asset value.  In addition, the general partner generally receives an allocation of partnership profits (net of prior losses and management fees) that is based on the master fund’s performance.  This is known as a carried interest.

Hedge Funds vs. Private Equity

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