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Because hedge funds disclose nothing to the government and very little to the public, nobody knows for sure, but the available data indicate that hedge fund assets have skyrocketed from $50 billion at the end of 1990 to $1.5 trillion in 2006. (Joint Committee on Taxation, "Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues, Part I" (JCX-62-07), p. 11, Doc 2007-20255 or 2007 TNT 172-12.)

The usual hedge fund setup is a master-feeder arrangement. The "master" hedge fund itself is organized as a partnership in a tax and banking haven, giving it foreign residence according to the code. The leading domiciles for offshore hedge funds are the Cayman Islands, the British Virgin Islands, Bermuda, and the Bahamas.

The fund has two "feeders" that invest as partners: the domestic feeder for U.S. resident taxable investors and the foreign feeder for foreign investors and U.S. tax-exempt investors. The domestic feeder is a limited partnership, so all of its items of income, gain, deduction, or loss pass through to its partners.

The foreign feeder is usually a corporation organized in a no-tax jurisdiction. A corporation, as we shall see, provides anonymity to investors, blocks exempt investors from being considered owners of certain kinds of assets, and avoids putting foreign investors directly in a U.S. trade or business that generates effectively connected income.