A common practice for alternative investment funds, such as private equity and hedge funds, and even some family offices, is to grant the managing partner a share in the fund`s profits. Unless a law firm recommends that the GP be treated as a partner or member for legal purposes of the state at the time of grant, the GP should consider making a contribution of less than 0.1% of the total capital to the fund or USD 100,000 in order to obtain immediate capital, unless a law firm indicates: that the first year of a partnership is not a regular distribution or allocation of profits. This equity participation ensures that the family doctor is a partner on the first day. If the GP is itself a partnership with several partners, each partner in the GP unit does not have to pay separately the lower amount of 0.1% of the total capital to the fund or 100,000 USD. The GP`s contribution may be shared among the GP`s partners, or even only supported by certain partners. There is no section of code that imposes a particular form for a focused interest. A partnership agreement is effectively a contract between partners within a fund and if the agreement provides for one or more partners to receive a profit allocation, the IRS will respect this allocation even if the interest on the profits is not accompanied by a share of the capital. In other words, the existence or absence of an interest rate on capital does not in itself alter the nature of the income allocated by an interest rate on profits. The relevant IRS guidelines do not require that capital be contributed in exchange for profit interest and in fact assume that no capital is actually contributed. Nevertheless, lawyers will often advise that the family doctor commit to a capital commitment. The simple reason is that the family doctor is recognized as a partner in the fund on the first day.
Take as an example the family physician and the limited partner (LP) invest in a limited partnership (the fund). LP invests 100 $US, the PM invests 0$US, and the partnership agreement stipulates that LP recovers its capital commitment, plus 10 $US (the preferred return). Then, the profits are divided 80% between LPs and 20% between GPs. If a gain of $20 is realized in year 1, the first $10 will be awarded to LP for the preferred performance, and the remaining $10 $US will be awarded to LP $8 and GP US$2. Capital accounts at year-end are US$118 for LP and US$2 for GP. Unlike management fees, which are lump sum fees paid independently of the benefit and taxed as ordinary income, profit-sharing motivates the supplement (GP) to maximize the long-term profits of the fund. This interest in earnings, known as the Carried Interest, allows the GP to be rewarded both for the fund`s successes and to benefit from preferential tax rates on the Fund`s long-term capital gains and eligible dividends. .