The 457A provision of the US tax code, passed in 2008, changes the ability of offshore hedge fund managers to defer taxes on certain types of Conditional Income. Eligibility for deferral requires meeting specific requirements, and the IRS considers any 457A/409A income constructively received in the current tax year.
457A is a provision of the United States tax code. It was passed in 2008 as part of the Emergency Economic Stabilization Act of 2008. The main intended effect of the original bill passed by the House of Representatives was to change the ability of offshore hedge fund managers to defer taxes on certain types of Conditional Income. This provision modifies section 409A of the tax code, but many of the definitions of 409A are included in 457A. Section 409A provided an IRA-like income tax deferral for people with very high incomes.
To be eligible for the deferral, compensation must meet three requirements. First, it refers to compensation for work performed or services rendered, and the contractor or employee must agree to be paid in a future year other than when the work was completed, often at retirement. Section 457a includes phantom units, which are equity units that have appreciated in value. However, it does not include any compensation that will be billed within the next 12 months if there is no risk that the compensation will not be paid.
The employer must meet both requirements for a non-qualified entity. First, the employer is a foreign company that does not receive the majority of its income as a result of a connection with a trade or business in the United States, nor does it pay full taxes on the foreign income. Second, the corporate partnership must not pay the majority of its income either to foreign persons who pay global foreign income taxes or to organizations that do not pay federal income taxes.
Finally, there must be no credible risk that the employee or contractor will not be compensated. There are two exceptions to this rule. First, the gains from any investment asset do not qualify as non-compensation risk. An investment asset is defined as a single asset, not a fund of any kind, that the entity is not involved in actively managing, and the proceeds are distributed to investors. The rule also does not apply under this provision if the income is deductible under section 882 of the federal tax code.
The IRS will consider any 457A/409A income constructively received in the current tax year and taxes due in that year. To further complicate 457A, the Senate decided to rewrite the original House bill. The resulting language change makes the rescission of the tax deferral potentially applicable to some domestic situations, including private investment funds and venture capital funds.
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