We offer tax compliance services for investment funds, managers and individual owners.
Tax compliance includes tax planning and annual tax return preparation, including investor K-1s at year-end. After year-end, general partners of hedge funds need to provide investors with annual income tax reports. Schedule K-1s pass through all items of income, loss and expense, retaining their underlying character of income or loss. Underlying character includes lower 60/40 tax rates on Section 1256 contracts (futures), short-term or long-term capital gains or losses on securities or ordinary income or loss from Section 988 forex.
Carried-interest tax break
The carried-interest tax break can be used in hedge funds, but it cannot be used in separately managed accounts (SMAs). If carried interest provisions are included in the fund’s operating agreement and PPM, the general partner investor is allocated a partnership K-1 share of each item of income — let’s say 20% — in lieu of the fund paying an outside advisor an incentive fee. Generally, the general partner and investors receive tax breaks in connection with carried interest. The advisor receives a share of lower tax rates on 60/40 or long-term capital gains, and the investor avoids investment expense treatment, which often is disallowed for AMT or doesn’t exceed the 2% of AGI limitation for miscellaneous itemized deductions.
Carried interest remains high on the list of “tax loopholes” facing repeal in discussions for tax reform, but we have written many blogs and articles defending it. Carried interest can be arranged in offshore funds with a mini-feeder structure. There are other nuances in connection with self-employment tax and the ObamaCare 3.8% Medicare tax on unearned income (investment income). We cover all these issues on our blog and in Green’s Trader Tax Guide.
Tax treatment elections
There are different types of tax treatment elections that can be made and it’s important to make the right decisions on time. In some cases, these tax elections should be contemplated in the development process and included in the private placement memorandum. For example, investors with large capital loss carryovers may be searching for hedge funds that will generate capital gains rather than Section 475 MTM ordinary income on securities or Section 988 ordinary income on forex. You can have capital gains treatment on both securities and forex.
Most investors benefit from trader tax status (TTS), so if your fund qualifies, it’s generally a good idea to claim that status. With TTS, the advisor and investors get business expense treatment without passive loss activity limitations. (One exception: non-active owners report investment interest expense as itemized deductions.) That means investors get the full benefit of advisory fees paid “above the line” (from gross income) rather than face many restrictions as itemized deductions below the line. With TTS, the fund is entitled to elect Section 475 mark-to-market (MTM) (on securities only), which exempts the fund from dreaded wash sales at year-end, plus Section 475 receives business ordinary loss treatment, avoiding capital loss limitations. Some managers skip a Section 475 election because they don’t want to be burdened with contemporaneous segregation rules for investments vs. business positions and they don’t want MTM to apply at year-end, so they can defer capital gains to the next tax year(s). Otherwise, they would pass MTM income to investors who might want redemptions to pay taxes and the manager has not yet sold those underlying shares. TTS and Section 475 issues are highly nuanced and often misunderstood, so advisors should discuss them with us in advance. Some hedge funds have TTS and Section 475 MTM on one portfolio, and they properly segregate an investment portfolio without TTS, where they generate long-term capital gains. (Read our blog IRS warns Section 475 traders for more about segregation of investments.)
Our tax compliance service includes everything you need
Our CPAs plan and prepare tax compliance for hedge funds, management companies and the individuals owning the management company. We help managers plan their tax matters in a way that suits their needs and their investors’ needs. While some tax breaks help both the manager and investors, others may help only one of them, while still others may help one at the expense of the other. For example, if the fund doesn’t qualify for trader tax status, carried interest helps both the manager and the investors. But in a futures fund with lower 60/40 tax rates, carried interest may only help the manager.
Green, Neuschwander & Manning, LLC knows every state very well. Use our professionals to conceive and structure the best tax plans for your fund and get them incorporated into the fund documents; then, use our CPAs to execute those plans and tax elections on a timely basis.
Tax edge: Count on us to handle all the tax matters correctly, including carried-interest tax breaks, the S-corp self-employment tax loophole, the new 3.8% Medicare tax on unearned income, trader tax status/Section 475 MTM accounting, lower 60/40 Section 1256(g) forex tax treatment breaks, forex tax treatment, ETF and ETF option tax treatment, international tax planning including PFIC and QEF elections, mini-master feeders, tax changes and more.
One big tax change started on Jan. 1, 2013: the Medicare 3.8% tax on unearned income, principally investment income. (Read about that in our Trader Tax Center page for Net Investment Tax.)
For more information on our tax strategies for investment managers, see Green’s Trader Tax Guide, our blog and Webinars.
Ready For Help?
Tax compliance, planning and annual tax return preparation services:
Green, Neuschwander will prepare the federal and all required state tax returns for your hedge funds and other investment vehicles. We also can prepare the tax returns for your management companies and your individual return. Click Tax Compliance (Preparation and Planning) and choose Investment Management.
Need help with accounting?
We offer those services, too. Click Investment Management: Accounting.
We look forward to working with you soon.
Robert A. Green, CPA & Darren L. Neuschwander, CPA
Managing Members of Green, Neuschwander & Manning, LLC (GNMTraderTax)