Accounting

1
Accounting Regulatory IssuesHedge Fund Tax
Trends andCurrent DevelopmentsNICSAs
Alternative Investments ConferenceNovember 14,
2002

• Howard Leventhal
• Partner, Ernst Young LLP

2
PROPOSED TAX LEGISLATION UPDATE
S.1971 National Employee Savings and Trust Equity
Guarantee Act (NESTEG)

• Targets
• Non Qualified Deferred Compensation Arrangements
  Funded with Assets Located outside the U.S.
• Principles of Non Qualified Deferred Compensation
  Plans
• Potential Impact on Hedge Fund Managers
• IRS

3
TAX DEFERRED LIFE INSURANCE AND ANNUITY PRODUCTS

• Tax Favored Product
• Recent Trend - Wrapping Hedge Fund into Product
• Letter Ruling 200244001 Hedge Funds Sold Purely
  through Insurance Companies Qualify

4
TAX SHELTER DISCLOSURE NEW TEMPORARY REGULATIONS

• Material Advisors must maintain and provide to
  IRS upon request list of investors in any
  Reportable Transaction
• Investors in Reportable Transactions required
  to attach special disclosure form (Form 8886) to
  tax return and copy to IRS Office of Tax Shelter
  Analysis

5
TAX SHELTER DISCLOSURE NEW TEMPORARY REGULATIONS

• Material Advisor is any person
• Who receives a fee (250,000/50,000)
• Provides or makes statement as to tax consequences

6
TAX SHELTER DISCLOSURE NEW TEMPORARY REGULATIONS

• Reportable Transactions
• 165 Loss Transactions that will or may
  reasonably be expected to result (Gross Basis)
• 5 million/10 million partnerships
• Listed Transactions
• Confidential Transactions Proprietary or
  Exclusive Transactions with Contractual
  Protection Indemnities as to tax consequences
• Significant Book/Tax Differences
• Transactions involving brief holding period

7
TAX SHELTER DISCLOSURE NEW TEMPORARY REGULATIONS

• Direct and indirect participants required to
  disclose
• RICs mainly exempt
• Effective Date 1/1/2003

8
SINGLE STOCK FUTURES

• Recent U.S. Product Launch NASDAQ/LIFFE
  MARKETS ONE CHICAGO
• 1256 Mark-to-Market Principles do not apply to
  non dealers
• 1234B Applies Specific for SFCs
• Normal Recognition Principles
• STCG and STCL for Non Dealers
• Wash Sale, Constructive Sales and Straddle Rules
  Applicable

9
TAX STRATEGIES FOR CAPITAL LOSSES

• Wash Sale Minimization
• Recognize Loss on Holdings
• Convert LTCL to STCL

10
WASH SALE MINIMIZATION

• Double Up for 31 Days
• Double Up and Sell Call Options
• Double Up and Sell Call and Buy Put
• Sell Loss Securities and enter into Basket Swap

11
RECOGNIZE LOSS HOLDINGS
Realize loss while maintaining interest in the
stock

• Begin with unrealized loss on long position
• Purchase out of the money call
• Sell stock for a loss
• Repurchase long stock
• Under wash sale rule, loss is deferred into call
  under FIFO ordering rule
• Hold repurchased long at least 31 days before
  cash settling call

12
CONVERT LTCL TO STCL(LONG POSITIONS)

• Sell LT stock for a loss
• Purchase call option
• Exercise call option
• Sell newly acquired stock
• Result Exercise of option resets holding period
  of newly acquired stock