Daily Tax Update - July 7, 2008

THE IRS ISSUES REVENUE RULING ON TREATMENT OF INVESTMENT MANAGEMENT FEES IN FUND OF FUNDS STRUCTURES: On July 3, 2008, the IRS issued Revenue Ruling 2008-39, which provides for the tax treatment of investment management fees paid by upper-tier and lower-tier partnerships in so-called “fund of funds” structures. The described structure involves an individual owning a limited partnership interest in a partnership (the “upper-tier partnership”) that, in turn, owns a limited partnership interest in several other partnerships (the “lower-tier partnerships”). The central issue addressed by the ruling is whether an investor who is an individual (the partner in the upper-tier partnership in the described structure) may treat its distributive share of the investment management fees paid by the upper-tier partnership as a section 162 business expense where (i) each of the lower-tier partnerships qualify as engaging in a trade or business within the meaning of section 162, (ii) the upper-tier partnership's activities (without regard to the activities of the lower-tier partnerships) rise only to the level of holding interests in the lower-tier partnerships for the production of income within the meaning of section 212, and (iii) the management fees paid by the upper-tier partnership are not paid on behalf of any lower-tier partnership. Revenue Ruling 2008-39 concludes that, under these circumstances, the management fees paid by the upper-tier partnership constitute section 212 expenses (not section 162 expenses), which causes such investor's distributive share of such management fees to be subject to the general limitations on itemized deductions and disallowance under the alternative minimum tax rules. 

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