2017 Recognition of Offshore Deferred Compensation for Investment Fund Managers: Federal and State Perspectives

    A once-popular strategy utilized by U.S.-based fund managers to defer the tax on revenues derived from offshore funds was eliminated in 2008 via changes to Section 457A.  At that time, Congress provided a 10-year grace period for plans then-presently in place.  Under this provision, the value of the plan’s balance as of December 31, 2017 is subject to taxation as deferred compensation at ordinary tax rates if not previously subject to tax.  As this deadline is quickly approaching, there is a renewed focus on this matter.

    Additionally, state taxing authorities are also taking steps to ensure that they reap the benefits from these additional revenues.

    Strategies from a Federal Tax Perspective

    While the 2017 recognition of income under Section 457A at December 21, 2017 is unavoidable, some fund managers have been considering the use of charitable gifts and trusts to soften the impact of the tax.

    If the amount of deferred compensation received is contributed to a qualified charitable organization, the taxation of such deferred compensation will be offset by a charitable deduction (leaving aside certain charitable deduction limitations that may apply).  A similar strategy, but with potential additional benefits to the fund manager and/or their family members, is to contribute to a grantor charitable lead annuity trust (CLAT).  This will provide the same upfront charitable deduction as an outright contribution to a charity, and still allow the family to keep investment returns over a monthly set federal interest rate (currently ~2.4%).  Under this approach, the grantor will recognize taxable income generated by the trust over either the trust term or the grantor’s lifetime.  A potential further enhancement involves the use of private placement life insurance within the CLAT.

    State Tax Perspective

    The 10-year grace period provided under Section 457A may also have state income tax ramifications.  Investment fund managers who deferred such compensation may need to report that income to the state in which it was earned at the time of the deferral, regardless of the taxpayer’s state of residency when the income is reported.

    By way of example, New Jersey recently issued a reminder to hedge fund managers who deferred compensation under Section 457A and must report and pay tax on the deferred compensation for federal purposes in 2017.  New Jersey’s reminder states that if the deferred income was sourced to New Jersey at the time it was earned, it would also be reportable and taxable on a New Jersey nonresident’s New Jersey Gross Income Tax return (Form NJ-1040NR) in the same year as it is reported for federal tax purposes.  As such, hedge fund managers must source compensation deferred under Section 457A to New Jersey to the extent the income was attributable to New Jersey at the time it was earned and deferred. 

    What Does CohnReznick Think?

    For investment fund managers that have not already done so, they should be considering planning options relating to the inclusion of deferred compensation for the 2017 tax year.

    Furthermore, state tax authorities are cognizant of the potential for additional revenues within their jurisdictions and we expect they will be extremely diligent in seeking out taxpayers that have previously benefited from this deferral strategy.


    For more information, please contact David Logan, Partner, Financial Services Industry Tax Practice Leader, at 646-601-7794 or [email protected]

    Learn more about CohnReznick’s Financial Services Industry Practice.


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    Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.