Key Takeaways
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Coordinated tax planning across management companies and fund owners is critical to aligning income, deduction timing and estate planning strategies before year-end.
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Accelerated deductions — including bonuses, depreciation and retirement contributions — require careful review to optimize entity and owner-level tax outcomes.
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Pass-through entity tax (PTET) elections, charitable giving and annual gifting exclusions offer effective ways to reduce income and transfer wealth tax efficiently.
Given the significant demands placed on fund executives and CFOs — particularly in portfolio management and capital raising — tax planning is often overlooked. Tax considerations arise throughout the entire fund lifecycle, however, underscoring the ongoing need for thoughtful and proactive tax planning. Because of the interplay between management companies and their owners, year-end is an ideal time to align tax planning across the entity and owner levels, for both income and estate tax purposes.
In this article, we highlight key tax planning considerations for management companies of fund structures as well as their respective owners.
The Management Company
Most hedge fund and private equity management companies operate as pass-through entities, typically LLCs, LPs or S Corporations. This means that the entity’s net income, loss or other specific tax attributes are passed through to the entity’s individual partners via Schedule K-1, making coordination between entity-level activity and owner-level planning essential.
PKF O’Connor Davies Observations:
- In a year where the management company’s income is relatively low, the owners might wish to accelerate taxable income at the personal level through a Roth Conversion or at the entity level by deferring deductions (e.g., delaying bonuses or opting out of bonus depreciation).
- In high-income years, the owners might want to accelerate deductions or review timing of large expenses to minimize taxable income.
Cash Bonuses
Management fees are typically received quarterly in advance. Salaries and discretionary bonuses often represent the management company’s largest expense, making their timing particularly important. Determining when and how bonuses are paid is critical to optimizing the owners’ personal tax position.
For example, if the management company operates on a cash basis, expenses are deductible when paid and the bonus income is generally taxable to the recipient upon receipt. Therefore, bonuses must be paid before year-end for the company to claim the deduction in that same tax year.
Conversely, if the management company operates on an accrual basis, it may deduct year-end bonuses paid in the following tax year, provided the bonuses were properly accrued by year-end and paid no later than March 15 of the subsequent year.
PKF O’Connor Davies Observation: Review your bonus accrual procedures to ensure proper deductibility under the Recurring Item Exception, which permits certain accrual-basis taxpayers to deduct specific recurring expenses in the current tax year, even if the related liability is not paid until the following year.
IRC Section 179 and Bonus Depreciation
Under the One Big Beautiful Bill Act (OBBBA), bonus depreciation has been restored to 100% for qualified property acquired and placed in service after January 19, 2025. In addition, the IRC Section 179 expensing limit was increased to $2.5 million, with a phaseout beginning at $4 million, both indexed for inflation.
Consideration should be given to whether the entity should opt into or out of bonus depreciation in situations such as:
- Current and future tax rates.
- Current and future year taxable income or loss.
- The IRC Section 461 limitation which restricts noncorporate taxpayers — such as individuals, trusts and estates — from deducting business losses that exceed a specified annual threshold ($610,000 for joint filers and $305,000 for others in 2025). Any disallowed losses are carried forward as net operating losses (NOLs) to future tax years.
Although these elections are generally made when filing the management company’s tax return, it is essential at year-end to understand how accelerated deductions may affect both the management company’s and the individual partners’ taxable income.
Pass-Through Entity Tax (PTET)
Under OBBBA, the federal, state and local tax deduction cap rises to $40,000 for joint and single filers beginning in tax year 2025 (and $20,000 for married taxpayers filing separately). This enhanced cap, however, phases out once a taxpayer’s modified adjusted gross income (MAGI) exceeds certain thresholds — generally $500,000 for joint and single filers and $250,000 for married filing separately — by reducing the benefit by 30% of income exceeding the threshold until it returns to the standard $10,000 cap. As a result, taxpayers in the highest income brackets will likely receive no benefit from this change in law.
As a result, pass-through entity tax (PTET) elections continue to serve as an effective state and local tax (SALT) cap workaround, allowing pass-through entities to pay state taxes directly at the entity level, reducing the income that passes through to the owners. Additionally, PTET planning can serve as a strategic employee retention tool by granting profit interests to key performers, perhaps in the general partner vehicle, allowing them to share in the benefits of the PTET deduction as these elections do not benefit a W-2 employee.
PKF O’Connor Davies Observations:
- Evaluate the location of any remote employees before year-end. When a partnership employs individuals who work remotely in a state where it has not previously operated, their presence may create nexus for state tax purposes — potentially subjecting the entity to income, franchise, payroll or other state-level taxes. Given the potential for state-sourced income allocable to both the entity and its owners, the partnership should consider making an entity-level pass-through entity (PTE) election in those states, where available. Because each state has its own rules, procedures and election deadlines, it is essential to consult with your tax advisor to ensure the election is made correctly and on time.
- To the extent that loss-harvesting accounts are being utilized by a taxpayer, they should not be held within the PTE structure, as the realized losses generated could reduce the tax benefits available to the entity. Instead, maintain these accounts in your personal name — this approach preserves the same federal tax advantages while preventing any erosion of the PTE’s overall tax efficiency.
Retirement Plans
Another effective way to reduce current income tax obligations is by contributing to a tax-deferred or tax-free retirement plan. In addition to the immediate tax benefits, implementing a well-structured retirement program can also serve as a valuable tool for attracting and retaining top talent. A variety of plan options — such as 401(k) plans, profit-sharing arrangements, cash balance plans and defined benefit plans — can help partners optimize their overall tax and retirement strategies. Each plan has its own eligibility, funding and compliance requirements and some may be required to be established before year-end, underscoring the importance of proactive planning.
Philanthropy and Charitable Contributions
Management companies structured as partnerships that conduct business within New York City and have total gross income exceeding $95,000 are subject to the New York City Unincorporated Business Tax (UBT) at a rate of 4%.
New York City allows a UBT deduction for charitable contributions made by the partnership, however, provided the contributions would also be deductible for federal income tax purposes. While certain requirements and limitations apply, this is an often-overlooked deduction that can provide meaningful tax savings at the entity level.
Meals
Beginning in 2026, employer-provided meals will become non-deductible unless the value of the meals is included in the employee’s taxable income. For 2025, these meals remain 50% deductible. Ordinary business meals with clients or employees at restaurants, however, will continue to be 50% deductible, while team-building activities or social events — such as holiday parties — will remain 100% deductible.
The Individual Fund Manager
Tax Rate Environment
The cornerstone of effective tax planning is a thorough understanding of the tax environment faced by both the management company and its partners. Partners and CFOs often become complacent, assuming that prepaying expenses and reducing taxable income are always the best strategies — yet this is not always the case. The character of income and the timing of deductions are critical factors. For example, a person might earn significantly more income in one year than in another yet end up with a lower overall tax rate in the higher-income year, depending on the nature of their income (e.g., long-term capital gains versus standard ordinary income). This is an important distinction because the tax benefit of a deduction or the effect of recognizing income can differ greatly from year to year.
Charity
There are two major changes to charitable contribution deductions under OBBBA, both of which are effective for tax years beginning January 1, 2026:
- For individuals who itemize, charitable deductions will be allowed only to the extent that total contributions exceed 0.5% of their adjusted gross income (AGI).
- For individuals in the top tax bracket, the tax benefit of charitable contributions will be capped at 35 cents of tax savings per dollar of contribution.
Example:
Let’s compare the federal tax benefit from a $1,000,000 charitable contribution in 2025 versus 2026, assuming the taxpayer is married filing jointly, in the top tax bracket and has $20,000,000 of AGI and all of it is comprised of ordinary income.
2025 – Current Rules
The taxpayer’s $1,000,000 contribution would yield a federal tax benefit of $370,000 ($1,000,000 × 37%)
2026 – Prospective Rules
- A new 0.5% of AGI floor applies — charitable deductions are allowed only to the extent contributions exceed 0.5% of AGI.
- 0.5% of $20,000,000 = $100,000, meaning only $900,000 of the $1,000,000 contribution is deductible. PLUS
- The value of the deduction for top earners is capped at 35%, even if their marginal tax rate is higher.
- Tax benefit is $900,000 × 35% = $315,000.
Therefore, compared to the 2025 benefit of $370,000, the same $1,000,000 charitable contribution in 2026 yields a reduced tax benefit of $55,000.
PKF O’Connor Davies Observations: Consider accelerating charitable contributions into 2025 to avoid the new AGI floor and the deduction cap taking effect in 2026. In addition, evaluate the interaction with the UBT benefit discussed above, as coordinated planning may enhance the overall tax efficiency of both strategies.
Gifting — Start Early
For 2025, the annual gift tax exclusion is $19,000 per donee (or $38,000 for married couples electing gift-splitting). This means a couple with three children can currently transfer $114,000 ($38,000 × 3) out of their estate each year gift-tax free. All future appreciation on the transferred assets then accrues outside the donor’s estate, enhancing long-term estate planning efficiency. In practice, many general partners (GPs) overlook this simple yet powerful strategy throughout the fund lifecycle — from formation to liquidation.
Lifetime Exemption
The lifetime estate and gift tax exemption is currently $13.99 million per individual in 2025 and will rise to $15,000,000 per individual in 2026. Taxpayers should consider proactively utilizing exemption amounts to maximize long-term estate planning opportunities.
PKF O’Connor Davies Observation: Revisiting one’s estate plan every five years — or whenever a significant life event occurs — is essential to ensure that the plan remains aligned with current goals, laws and financial circumstances.
Previous Gain Deferrals into Qualified Opportunity Zones (QOZ)
QOZ investments made in 2019 and held for seven years or made in 2021 and held for five years qualified for a 10% or 15% step-up in basis, respectively. Additionally, the deferred gain will be recognized as taxable income in 2026 and must be reported on the 2026 tax return filed in 2027.
PKF O’Connor Davies Observation: The character of the deferred gain remains unchanged — meaning that if the original gain was short-term, it will not convert to long-term, even after a five- or seven-year holding period.
Conclusion
Year-end planning should be viewed as part of a comprehensive, year-round tax strategy. Every taxpayer’s situation is unique, with a range of planning opportunities available depending on factors such as entity structure, income composition and ownership dynamics.
Proactive planning allows for the maximization of deductions, strategic timing of income recognition and effective long-term wealth transfer.
Contact Us
If you have any questions, please contact your PKF O’Connor Davies client service team or:
Alan S. Kufeld, CPA
Partner
akufeld@pkfod.com
John P. Kavanaugh, CPA
Partner
jkavanaugh@pkfod.com
Benjamin A. Beskovic, CPA, CGMA
Partner
bbeskovic@pkfod.com