There are also more complicated alternatives: incorporate your management company overseas with a bunch of foreign directors. Treat your management company as an operating company (ie don’t check the box) for US tax purposes. Depending on the tax treaty between where you incorporate and the US, you might be able to get both nominal corporate tax locally on the inflows and dividend tax treatment in the US on the outflows, with the added benefit of the IRS not looking through the foreign management company to see its fee arrangements with the foreign partnerships it manages.

More broadly, the fund benefits by being able to reshape its form with virtually no impact on its actual substance or operations, and therefore mimic other businesses that have more political clout. No need to try to convince lawmakers to have sympathy for hedge funds when the hedge funds can pretend to be realtors or cotton farmers and watch the government close its eyes.

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Sure, but there are limits to such game playing. If options are granted for free, IRS will try to tax grant as compensation at ordinary rates. If options are purported to be issued for cash, IRS can argue price was too low and the discount is compensation taxable at ordinary rates. Likewise if the GP is lent money non-recourse by a GP to buy a fund interest or if the GP contributes a non-recourse note to buy an interest in the fund and the loan/note is secured solely by the GP’s interest in the fund, risk that the IRS claims the loan and fund interest are in substance a carried interest.