Save on Estate Taxes by Gifting Your Carried Interest

A career in private equity offers the potential for tremendous wealth creation. Unfortunately, it may also come with a tax bill to match. We believe one of the most overlooked tax consequences for private equity professionals is the potential for estate taxes to take a bite out of their family’s long-term wealth. Gifting your carried interest to younger generations is one strategy that may help.

Why gift carried interest?

If you hold carried interest in a fund, especially a newer one, that interest may not have a tremendous value today, but if the fund is successful, your carried interest could eventually be worth hundreds of times its current value.

If that carried interest were subject to estate tax, you could be liable for federal taxes of 40%, plus any state or local taxes that might be due. Granted, in 2024, federal taxes don’t kick in until your estate is worth $13.61 million,¹ but with the Tax Cuts and Jobs Act set to sunset at the end of 2025, your taxes could rise when tax rates return to their former pre-2018 level.²

For many private equity professionals, an effective solution may be to transfer their carried interest into a trust for their children and/or grandchildren, or to use a derivatives contract to create a gift for them, before it increases significantly in value, potentially avoiding a heavy estate tax burden.

How much should you gift?

For this strategy to work, the carried interest gift must be irrevocable. Once the funds are placed in a trust, it may be difficult or impossible to take them back—at least not without incurring legal fees and risking negative tax consequences.³ Therefore, we believe it’s important to ensure that your own retirement and spending needs are fully met before you determine your gift for the next generation.

We recently implemented a carried interest gifting strategy for a client of ours. The process involved both subjective visualization and decision-making about how he wanted his life to look, now and in the future. The process also involved detailed quantitative analysis that included modeling his portfolio, spending patterns and future goals using a Monte Carlo simulation.

We strongly recommend working with your Corient Wealth Advisor to gain clarity on your personal financial requirements and peace of mind regarding the right size of your gift.

What will be the impact of your gift?

Of course, your life plans are not the only ones that should be considered. Depending on the age of the recipients, you’ll want to be mindful of how much to gift and when to allow access to that gift. A trust structure may allow you some control over how and when the money is managed and dispersed.

For example, you may wish to structure a trust so that funds are released as the recipients cross certain thresholds in life, such as graduating college, purchasing a home, getting married or having kids of their own.

What else might you consider?

Gifting carried interest is not without its risks and complications. For example, if your carried interest is subject to a vesting schedule, it may attract additional gift taxes when it eventually vests.⁴ And, given the speculative nature of the investment, there’s a chance you could use up your gift tax exemption today, only to have the carried interest end up being worthless in the long run.

One potential way to minimize these risks is to create a derivative contract that allows you to retain ownership of your carried interest while transferring the economic benefit from it to future generations. Think of it as giving your kids or grandkids an option on some or all of the potential future value of your carried interest rather than gifting them the interest itself.⁵

No matter what gifting strategy you pursue, we believe it makes sense to have a Corient Wealth Advisor by your side, plus the appropriate tax and legal professionals to help ensure that you conduct the appropriate analysis, properly document your strategy and avoid any potential pitfalls.

As we said at the start, a career in private equity may offer the potential for tremendous wealth creation. We believe a gift of carried interest is something that may preserve and protect that wealth for generations to come.

¹ https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax
² https://www.thomsonreuters.com/en-us/posts/tax-and-accounting/tcja-expiring-provisions/
³ https://www.investopedia.com/terms/i/irrevocabletrust.asp
⁴ https://www.wealthmanagement.com/high-net-worth/gifting-carried-interest-derivatives#menu
⁵ https://www.wealthmanagement.com/high-net-worth/gifting-carried-interest-derivatives#menu

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