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Abstract: 

In early 2004, hedge funds that invest in notional principal contracts (“NPCs”) received some long-awaited guidance on the tax treatment of NPCs, including payments made or received pursuant to NPCs. Specifically, in February 2004, Treasury released proposed regulations (the “Proposed Regulations”) dealing principally with NPCs with contingent nonperiodic payments.1 While these regulations primarily affect the timing of contingent nonperiodic swap payments under Reg. 1.446-3, there are also some changes affecting the character of swap payments under Section 1234A and the deductibility of swap payments under Sections 162 and 212. Although these Proposed Regulations answer some basic questions relating to the character and timing of NPC payments, a number of questions are left unanswered, leaving many taxpayers and practitioners perhaps more uncertain than they were before. In many cases, taxpayers either already faced some of the issues addressed more thoroughly in this article or are currently facing them as they finalize their Schedule K-1s and tax returns for 2004.

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Affiliations:  1: Deloitte Tax LLP; 2: Deloitte Tax LLP.