A ruling last month by the Internal Revenue Service, limiting the ability of investors in funds of hedge funds to deduct management fees from their federal income taxes, could prompt some managers and their investors to either redo their tax forms or challenge the decision.

The question at the core of Revenue Ruling 2008-39 is whether funds-of-funds, because of their investments in underlying hedge funds, can categorize their own management fees as "trader expenses." In deciding that, for tax purposes, funds-of-funds should be considered investors and not traders, the IRS said that the fees must be treated as miscellaneous itemized investment expenses under Section 212 of the Internal Revenue Code.

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