Schedule K‐1 for Hedge Funds: Critical Issues
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Presenters Contact Information
E. George Teixeira, CPA,
Ron Hall
Partner, Financial Services
Anchin Block & Anchin LLP
Anchin, Block & Anchin LLP
1375 Broadway New York, New York 10018
(212) 863‐1298 Email: george.teixeira@anchin.com
Director of Accounting
Crederian Fund Services LLC
Crederian Fund Services LLC
Phone: 484‐443‐8795 Email: ron.hall@crederian.com
Rose Tree Corp. Center II, Suite 5035 1400 N. Providence Rd. Media, PA 19063 Jeffrey J. Bowden
Tax Principal
Anchin, Block & Anchin LLP
1375 Broadway New York, New York 10018
(212) 840‐3456
(212) 840‐3456 Email: jeffrey.bowden@anchin.com
Mike Quinn Senior Manager
Senior
Manager
Crederian Fund Services LLC Phone: 484‐443‐8794 Email: michael.quinn@crederian.com
Rose Tree Corp Center II Suite 5035
Rose Tree Corp. Center II, Suite 5035 1400 N. Providence Rd. Media, PA 19063 NOTICE
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.
Anchin at a Glance
• Largest single-office firm in the U.S.
• 53 partners,
partners staff of more than 350
• Named “Best Place to Work” in New York State (Society for Human
Resources Management)
• Named “Best Place to Work” in New York City (Crain’s)
• Named “Best Accounting Firm to Work For” (Accounting Today)
• Consistently one of top 30 largest firms in the United States (Inside
Public Accounting)
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Anchin at a Glance:
Financial Services Group
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SServes investment partnerships, hedge funds, funds‐of‐funds, private equity i
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hi h d f d f d f f d
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funds, off‐shore funds, master‐feeder structures, broker/dealers, mutual funds, investment advisers, and investment management companies
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Over 400 clients in the financial services industry
400 li t i th fi
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i
i d t
9 partners and 50 dedicated professionals
Anchin’s largest practice group by industry sector
Recognized as a leader in providing assurance and audit, tax, financial reporting, back office administration and business advisory services
Named “Best Accounting Firm in North America” (Hedgeweek Magazine)
Named “U.S. Overall Accountancy Firm of the Year” (Acquisition International Magazine’s International Hedge Fund Award)
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Crederian Fund Services at a Glance
• Located in the Philadelphia suburb of Media, PA
• SAS 70 Certified
SAS 70 Certified
• Focused on responding to client‐specific needs • Large firm experience, small firm attention to detail
• Client focused approach
Cli
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• Extensive financial services industry experience with a wide variety of: • Hedge Funds
• Mutual Funds
• Fund of Hedge Funds
• Private Equity Funds
Private Equity Funds
• Separately Managed Accounts
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Crederian Fund Services at a Glance
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Team‐Centric Approach to Full Administration
Team model
Team model One centralized operations contact
List of services:
• Full Administration F ll Ad i i
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• Accounting
• Investor Services
• Investor Recordkeeping
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Agenda
– Schedule K‐1 Introduction & Overview
– Hedge Fund Structures
– Net Investment Income Tax
– Schedule K‐1 Preparation – Matters to Consider
– K‐1 Line Placements and Common Footnotes
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Schedule K‐1 Introduction & Overview
 2013 Form 1065 (Schedule K‐
1) ‐ Final version
• What’s New (compared to 2012 Schedule K‐1)?
• Part III, Box 20 Other Information, Part III Box 20 Other Information
Code Y: Net Investment Income
• Other relevant sections of the S h d l K 1?
Schedule K‐1?  What is a Hedge Fund?
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2013 Schedule K‐1 ‐ Final
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2013 Schedule K‐1 ‐ Final
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What is a Hedge Fund?
 A Hedge Fund may be described as a pool of private capital used to leverage an investment portfolio structured as a Limited Partnership or Limited Liability Company.
p
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 Also known as Investment Partnerships.
 Buy/sell securities
 Traders; Investors; Fund of Funds
Traders; Investors; Fund of Funds
 LLCs and LPs are taxed as partnerships: a partnership’s taxable income including items of income, gains, expense, l
loss, and credit flows through to the investors, who are d dit fl
th
h t th i
t
h
subject to tax on such amounts.
 Generally not taxable entities
 Beware state/local tax issues (i.e., NYC UBT, etc)
 A hedge fund uses Schedule K‐1 to report each partner’s share of such taxable income items. A copy of each K‐1 is provided to the IRS.
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Polling Word #1
Polling Word #1
• Polling Word #1 is: HEDGE
• Individuals – maximize the polling web page at the bottom of y
your screen. Please choose the correct response and click p
“submit.” Then, click the “go to the next question” button and minimize the web page until the next polling word is announced.
• Group members who need CPE – you do not need to write down and submit responses to the polling words. Hedge Fund Structures
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Introduction
Side‐by‐Side (aka Parallel Funds)
Side‐by‐Side (aka Parallel Funds)
Master Feeder
Form 8832 – Entity Classification
Recap – IRC Section 457A
Mini Master
Modified Mini Master
Modified Mini Master
Master Feeder (revisited)
Blocker Vehicles
Off h
Offshore PFIC Structure
PFIC St t
Funds of Funds (FOFs)
Carried Interest?
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Some Questions
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Why do we need different structures? – Why not a one‐size fits all approach?
– Do types of investors matter?
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– Do types of investment activity matter?
What issues should be considered in structuring a new (or restructuring an existing) fund?
– Tax Considerations?
• Minimizing tax
• Minimizing compliance burdens
• Maximizing privacy for non‐U.S. Investors
• How is the trader versus investor issue affecting the structuring of funds?
– Other Concerns?
• Section 457A
• Carried Interest changes (or proposals for change)
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What we hope to accomplish…
• Discuss the various types of hedge fund structures currently available
• Discuss the restructuring of Funds following IRC Section 457A (signed into law on October 3 2008)
457A (signed into law on October 3, 2008)
• Discuss check‐the‐box election and how they are used in tax structuring
• Discuss the need to revisit structuring issues on an ongoing basis
• Structures evolve as facts change and as applicable St t
l
f t h
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li bl
tax laws change
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SIDE-BY-SIDE
US
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
INVESTORS-U.S. TAXABLE
GP LLC
GP,
(DOMESTIC GP
FOR DOMESTIC
FUND)
OFFSHORE
MANAGEMENT CO
CO.
(MGMT CO.-LLC, LP
OR S-CORP.)
20% INCENTIVE
ALLOCATION
FUND LTD.
(OFFSHORE CORP TAXED AS
CORP-OFFSHORE
FEEDER)
FUND, LP
(DOMESTIC, LP)
Key
partnerships
Ownership
--------------- Not ownership
corporations
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US
MASTER-FEEDER - A
INVESTORS-U.S. TAXABLE
MANAGEMENT CO.
(MGMT CO.-LLC, LP
OR S-CORP.)
FUND, LP
(DOMESTIC, LP-US
FEEDER)
20% INCENTIVE
ALLOCATION
GP, LLC
(DOMESTIC GP
FOR
MASTER FUND
RECEIVING THE
INCENTIVE AND FOR
LIABILITY PURPOSES
FOR THE DOMESTIC
FUND)
OFFSHORE
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
FUND LTD.
(OFFSHORE CORP
TAXED AS CORPOFFSHORE
FEEDER)
MASTER FUND, LTD.
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
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Pros & Cons of Master‐Feeder (vs. Side‐by‐Side)
PROS • Single Portfolio for Administrative p
Purposes • Offshore Performance mirrors Onshore Performance • Tax Gains are not generated from Rebalanced Trades
• Derivative Positions and Illiquid Positions do not need to be rebalanced • Critical mass of money
Rule 144A investments
• Rule 144A investments
• Avoid splitting tickets and multiple counterparty agreements
• Expense of setting up; additional audit and tax return
and tax return
• ERISA; hard‐wiring
Cons
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Extra Entity for Audit and Tax purposes
Administration of U.S. withholding tax done by the Prime Broker
Foreign Partnership reporting obligation on Form 8865
Effectively Connected Income (ECI) concerns with some investments
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Investors may have different tax goals
Long‐term capital gains
Qualified dividend income
Withholding
FIRPTA investments; 5% determination
Portfolio interest; 10% determination
Portfolio interest; 10% determination
Trades between the entities
Prior to repeal of the ability to defer fees, looked better for deferral purposes
Need to issue K‐1 to offshore fund?
If a fund of funds, more complex on where to invest
Counting of slots, investor financial standards
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Polling Word #2
Polling Word #2
• Polling Word #2 is: FEEDER Form 8832 – Entity Classification
Purpose of Form ‐ An eligible entity uses Form 8832 to elect how it will be classified for federal tax purposes:
– as a corporation, – a partnership, p
p,
– or an entity disregarded as separate from its owner. – An eligible entity is classified for federal tax An eligible entity is classified for federal tax
purposes under the default rules unless it files Form 8832 or Form 2553, Election by a Small Business Corporation, to elect a classification or change its current classification.
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Form 8832 – Entity Classification
• Domestic Default Rule
– Partnership if it has two or more members
Partnership if it has two or more members
– Disregarded as an entity separate from its owner if it has a single owner
• Foreign Default Rules
– Partnership if it has two or more members and at least one member does not have limited liability
– An association taxable as a corporation if all members h
have limited liability
li it d li bilit
– Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability
has a single owner that does not have limited liability
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Form 8832 – Entity Classification
• Business entities are divided into two categories: 1.
2
2.
those that are treated as corporations per se and
“eligible
eligible entities.
entities ”
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Eligible Entities can make an entity classification election
• Per Se Domestic Corporations are corporations that are always classified as corporations. Per Se Domestic Corporations include:
– Business entities organized under Federal or State statute if that statute describes or refers to the entity as incorporated or as a corporation or y
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refers to the entity as a joint stock company or association
– Entities taxed as an Insurance Company
– State Chartered entities conducting Banking activities
State Chartered entities conducting Banking activities
– A business entity owned by a State or Foreign Government
– Tax Exempt Entities
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Form 8832 – Entity Classification
Form 8832 Entity Classification
• Per Se Foreign Corporations are foreign entities not eligible entities entitled to be titi
t li ibl
titi
titl d t b
classified as either a corporation or a partnership. partnership
• Treas. Reg. Section 301.7701‐2(b)(8) provides a list of foreign business entities that are
a list of foreign business entities that are always classified as corporations for U.S. federal tax purposes (the per se corporation
federal tax purposes (the per se corporation list) and where a check the box election may not be used.
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Form 8832 – Mechanics of the Election
• Due Date – An election specifying an eligible entity’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. • Must obtain a US EIN (complete Form SS‐4) in order to complete the form 8832 election.
• 60 Month Rule‐ Cannot change Election g
• Rev. Proc. 2009‐41 Late Election Relief
– Failed to file Form 8832
– Has not filed the return the election pertains to because the due date has not Has not filed the return the election pertains to because the due date has not
passed, or has filed all returns and information returns consistent with as if the entity classification was made – The entity has reasonable cause for failure to file the election – No later than 3 years and 75 days from the date the election was intended to take place
– ** if Rev Proc does not apply – need to try for PLR (Private Letter Ruling) relief  costly – takes time – may not be successful
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Recap ‐ IRC Section 457A
Basically eliminated deferrals
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Exception for short term deferrals. p
Are deferrals for 1 year basically but typically not a long enough period to be interested in
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Prior (deferred) fees were Prior
(deferred) fees were
grandfathered
Impact on fund structuring?
1. Existing Funds
2. New Funds
3 Master feeder structure? Mini
3.
Master feeder structure? Mini‐master?
master? Modified mini‐master? 21
US
MINI-MASTER
OFFSHORE
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
INVESTORS-U.S. TAXABLE
MANAGEMENT CO.
(MGMT CO.-LLC, LP OR
S-CORP.)
FUND LTD.
(OFFSHORE CORP TAXED AS
CORP-OFFSHORE
FEEDER)
GP, LLC
(DOMESTIC GP
FOR
BOTH FUNDS)
FUND, LP
(DOMESTIC, LP-US
Fund)
MINI MASTER FUND,
LTD.
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
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MODIFIED MINI-MASTER
US
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
INVESTORS-U.S. TAXABLE
GP, LLC
(DOMESTIC GP
FOR
DOMESTIC FUND)
OFFSHORE
MANAGEMENT CO.
(MGMT CO
CO.-LLC,
LLC LP
OR S-CORP.)
2% MANAGEMENT FEE
FOR BOTH FUNDS
20% INCENTIVE
ALLOCATION
CALCULATED AT
FEEDER FUNDS LEVEL
BUT REALLOCATED AT
THE DOMESTIC FUND
FUND LTD.
(OFFSHORE CORPS TAXED AS
CORP-OFFSHORE
FEEDER))
FUND, LP
(DOMESTIC, LP-US
FEEDER/ MASTER)
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US
MASTER-FEEDER - B
OFFSHORE
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
INVESTORS-U.S. TAXABLE
MANAGEMENT CO.
(MGMT CO.-LLC, LP
OR S-CORP.)
2% MANAGEMENT FEE
2% MANAGEMENT FEE
FUND LTD.
(OFFSHORE CORP
TAXED AS CORPOFFSHORE
FEEDER)
GP, LLC
(DOMESTIC GP
FOR
MASTER FUND
RECEIVING THE
INCENTIVE AND FOR
LIABILITY PURPOSES
FOR THE DOMESTIC
FUND)
20% INCENTIVE
ALLOCATION
FUND, LP
(DOMESTIC, LP-US
FEEDER)
MINI-MASTER
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
MASTER FUND, LTD.
(
(OFFSHORE
CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
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US
MASTER-FEEDER - C
INVESTORS-U.S. TAXABLE
MANAGEMENT CO.
(MGMT CO.-LLC, LP
OR S-CORP.)
OFFSHORE
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
GP, LLC
(DOMESTIC GP
FOR
MASTER FUND
RECEIVING THE
INCENTIVE AND FOR
LIABILITY PURPOSES
FOR THE DOMESTIC
FUND)
FUND, LP
(DOMESTIC, LP-US
FEEDER)
20% INCENTIVE
ALLOCATION
CALCULATED AT
FEEDER FUNDS LEVEL
BUT REALLOCATED AT
THE MASTER FUND
2% MANAGEMENT FEE
CALCULATED AT THE
FEEDER FUNDS LEVEL
BUT CHARGED AT THE
MASTER FUND
FUND LTD.
(OFFSHORE CORP
TAXED AS CORPOFFSHORE
FEEDER)
MASTER FUND, LTD.
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
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ECI and Non‐ECI Master‐Feeder Structures
• Objectives:
• Flexible ‐ Allows investors to participate in all investments
• Helps to mitigate US ECI exposure to non‐US investors and US tax exempt investors
and US tax‐exempt investors
• Considerations:
•U
Use of blockers (or series of blockers)
f bl k (
i
f bl k )
• Use of leverage
• Portfolio Interest (offshore funds as partnerships so can Portfolio Interest (offshore funds as partnerships so can
qualify interest from blocker as portfolio interest)
• Higher compliance costs
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US
MASTER-FEEDER – ECI/Non-ECI
MANAGEMENT CO.
(MGMT CO
CO.-LLC,
LLC LP
OR S-CORP.)
INVESTORS-U.S. TAXABLE
OFFSHORE
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
GP, LLC
(DOMESTIC
2% MANAGEMENT
FEE
Offshore Feeder
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
DEBT
FUND, LP
(DOMESTIC, LP-US
FEEDER)
US Corporate
Blocker
Offshore
Corporate
Blocker
ECI MASTER FUND,
LTD.
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
DEBT:
* Interest Stripping Rules (IRC §163(g)
* Debt or E it (IRC
Equity (IRC §385)
NON-ECI MASTER
FUND, LTD.
(OFFSHORE CORP OR
LP-CHECKING BOX TO
BE TAXED AS
PARTNERSHIP)
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Blocker Vehicles
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The term “blocker” is not defined in the Internal Revenue Code
in the Internal Revenue Code. It is used to refer to any entity that is interposed into a fund structure for the purpose of bl k
blocking undesirable tax effects d
bl
ff
to the investor or the fund that arise as a result of the identity of the investor or the nature of the underlying investment.
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Blocker entities have also historically been used to block yp
(
certain types of income (like UBTI) from flowing through to (tax‐exempt) investors 
offshore hedge funds…
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Blocker Vehicles
• The blocker entity (generally a U.S. C corporation) is subject to “double taxation”  Income of the corporation is taxed first at the corporate level (since the C corporation is not a pass through vehicle
the C corporation is not a pass‐through vehicle, shareholders are not directly taxed on this income); The second level of tax is at the shareholder level when the corporation distributes the income to the shareholders in the form of dividends.
• What about an “offshore” blocker for onshore investments – CFC issues – subpart F income – BAD NEWS…
NEWS
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OFFSHORE FUND (PFIC as the Master Fund)
OFFSHORE
O
S O
US
INVESTORS-U.S. TAXABLE
INVESTORS-FOREIGN
AND
US TAX-EXEMPT
MANAGEMENT CO.
(MGMT CO.-LLC, LP
OR S-CORP.)
FUND LTD.
(OFFSHORE CORP TAXED AS
CORP-OFFSHORE
FUND)
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Polling Word #3
Polling Word #3
• Polling Word #3 is: OFFSHORE PFIC as the Master Fund
• PFIC is a corporation – which is generally not a pass‐
through for U.S. tax purposes
– Shareholders can make the QEF election to get pass‐
through treatment
• Trader vs. Investor considerations
–U
Used to “net” expenses that could otherwise be subject to d t “ t”
th t
ld th
i b
bj t t
deduction limitations (portfolio deductions subject to 2% of AGI limitation); Management Fees; Professional Fees
– Investment Interest Expense limitations
– State and local limitation of itemized (portfolio) deductions
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PFIC as the Master Fund
Benefits
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Netting of capital gains/losses
Potential for LTCG treatment (w/
Potential for LTCG treatment (w/ QEF election)
Avoids the disallowance of “portfolio deductions” as long as the entity earns income
Provides simplicity to the structure (no need for multiple feeders…)
A f th
A further election to delay the l ti t d l th
payment of taxes (subject to an interest charge) may be a way to borrow $$ at a relatively moderate y
(aka low) interest rate
Intentional use of not making the QEF election
Disadvantages
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w/ QEF election – net income is taxed currently; net losses are NOT passed through (and lost forever?)
– Investors may be hesitant to make the QEF election and comply with the (additional) l ith th ( dditi
l)
reporting obligations
Potential for income in excess of current QEF inclusion
current QEF inclusion
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Withholding on U.S. source dividends and certain other income
d t i th i
–
•
Distribution is a dividend to the extent of PFICs overall E&P
FIRPTA; ECI Risk
Marketing the fund to different types of investors
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Fund‐of‐Funds (FOFs)
• All prior structure slides and principles generally apply for FOFs
• Exception – Management Fees:
– Revenue Ruling 2008‐39
– Incurred at feeder level for Master‐Feeder hedge fund – deductible “above‐the‐line” if Master is a trader (IRC Section 162)
– However, for FOFs, feeder fund level fees are IRC Section 212 portfolio deductions (or miscellaneous itemized deductions subject to 2% AGI limitation)
AGI limitation)
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Fund‐of‐Funds (FOFs)
• Tax and Compliance Considerations
– Passing through income, losses, credits, etc. from underlying fund investments to FOF investors
– Making a QEF election for any underlying PFIC investments
– Securing proper tax disclosures from underlying f d
funds
– Providing proper/complete tax disclosures to the FOF investors
FOF investors
– State filing requirements – both at the FOF level and for FOF investors including state K‐1s
and for FOF investors, including state K‐1s
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Potential Changes to Carried Interest?
• Pending legislation would make all allocations of carried interest 
f
i di
 Ordinary Income
O di
I
• Enterprise Value rule  would also treat any gain from the sale of an interest as ordinary income
• Crystal Ball  seems likely to pass at some p
point but difficult to assess timing, scope, and g,
p ,
effective dates at this time
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Potential Changes to Carried Interest ‐
‐ Affecting Manager/GP compensation?
Affecting Manager/GP compensation?
• No impact yet
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• Incentive fees vs. incentive allocations
– Also NII issues and planning opportunity
p
g pp
y
• If foreign principals, may need to restructure compensation method
• May be less need to split management fee from incentive allocation
• Sales of interest in investment manager and/or general partner
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Potential Changes to Carried Interest ‐
‐ Affecting Manager/GP compensation ‐ structuring?
• Why split incentive allocation from management fee
• Self‐employment tax –
Self employment tax – impact of carried interest impact of carried interest
proposal
– NII impact as well? S/E income is NOT included in NII
p
/
•
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•
Where does management company do business
Where do owners of management company reside
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LLC
Limited partnership
p
p
S corporation
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Polling Word #4
Polling Word #4
• Polling Word #4 is: INTEREST
Net Investment Income (NII) ‐ IRC Section 1411
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NII ‐ continued
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Effective as of 1/1/2013, an additional 3.8% NII tax on “net investment income” went into effect for taxpayers whose AGI (with certain modifications) exceeds a threshold amount.
Under the 2012 proposed regulations for funds that are “investors”
Under the 2012 proposed regulations, for funds that are investors rather than rather than
“traders,” the timing of the inclusion of potentially significant classes of income in the NII tax base was different from the timing of the inclusion in income for the regular income tax. This would have had the potential for creating significant compliance complexity. – Income from CFCs, PFICs, and income from “notional principal contracts.”
The 2013 regulations made substantial improvements to the 2012 proposals by eliminating much of the NII timing inclusion disparities between investing and trading funds. In addition, the final regulations eliminate a major concern created by the statute and the 2012 proposed regulations by effectively allowing capital gains and losses from investing and trading activities to be netted for purposes of
gains and losses from investing and trading activities to be netted for purposes of the NII tax. Other taxpayer‐friendly changes include favorable rules for taking into account for NII purposes the deduction limitations of Sections 67 and 68 of the code, and allowing net operating loss carry forwards in certain circumstances for purposes of the NII tax.
f th NII t
39
NII – continued
•
•
•
Net investment income generally includes gross income from interest, dividends, annuities, royalties, and rents and net gain from dispositions of property, as well as trade or business income which is income from a “passive activity” with respect to the taxpayer.
The Net Investment Income tax generally would apply to incentive allocations to
The Net Investment Income tax generally would apply to incentive allocations to investment manager general partners and to the investment returns for investors in funds. In contrast, fee income allocated to the limited partners of an investment manager could be excluded from the NII tax if the limited partners “ t i ll
“materially participate,” within the meaning of Section 469 of the code, in the ti i t ” ithi th
i
f S ti 469 f th
d i th
investment manager’s advisory trade or business.
Income thresholds and special rules
1 The threshold amount above which the NII tax can apply is: $250 000
1. The threshold amount above which the NII tax can apply is: $250,000, for taxpayers filing jointly (or as a surviving spouse); $125,000, for married taxpayers filing separately; and $200,000, for all other cases. These thresholds are not indexed for inflation.
2. Foreign tax credits are not creditable against the tax paid on NII (but may be deductible in determining NII).
3. Self‐employment income is not included in NII.
4 The NII tax does not apply to a nonresident alien or to a foreign trust
4. The NII tax does not apply to a nonresident alien or to a foreign trust
40
NII – continued
• Planning Considerations
– Management Company as limited partnership instead of LLC – active trade/business income (of a limited partner) not subject to SE or NII
trade/business income (of a limited partner) not subject to SE or NII tax . What about an S Corporation?
– Incentive as fee vs. allocation – NYC UBT vs. NII – GP vs. management company ‐ allocation of expenses
– Itemized deductions not deductible for AMT may be deductible for NII
– Allowable Tax exempt instruments
– Donate appreciated stock to charity
• Reporting
•
•
– Flow through entities
– 2013 Schedule K‐1 new line 20Y – net investment income
I di id l
Individuals, estates and trusts
t t
dt t
– Form 8960 – Net Investment Income Tax calculation form
Draft Form 8960 instructions are available currently; Form 8960 was finalized recently (in early January 2014)
finalized recently (in early January 2014)
41
NII ‐ continued
E l i f
Exclusion from NII:
NII
•
NII tax generally would apply to incentive allocations to investment manager general partners and to the l
d
h
investment returns for investors in funds. In contrast, fee income allocated to the limited partners of p
an investment manager could be excluded from the NII tax if the limited partners “materially participate ” within the meaning of
participate,” within the meaning of Section 469 of the code, in the investment manager’s advisory trade or business.
Wh t i M t i l P ti i ti ?
What is Material Participation?
Meet 1 of 7 material participation tests
1. More than 500 hours participation
2. Substantially all of the participation
3. More than 100 hours if no one has more
4. Significant participation activities
5. Material participation five of past 10 years
6. Material participation in personal service activity in any of three prior years
7 Facts and circumstances
7. Facts and circumstances
Limited Partners – meet 1 of 3 material participation tests…
participation tests…
42
NII ‐ continued
• For new (offshore or domestic) funds, managers may ( ff h
d
)f d
want to take into account the impact of the NII tax on structuring decisions:
on structuring decisions:
– Incentive compensation as an “allocation” or as a “fee”? Some factors to consider:
• How much LTCG is expected
• Whether or not there will be side pockets
• Whether the members of the manager will meet the “material participation” threshold with respect to the management company
management company
• Whether the fund will be a “trader” or “investor” and • The impact of entity level taxes (e.g., NYC Unincorporated Business Tax)
43
How do NII and S/E interact?
Sweet Spot?
S/E Income
§1402 tax
S Corporation: Non‐Salary
Partnership: Active Limited Partner?
NII
§1411 tax
S Corporation:
If not salary/wages, then not subject to S/E tax  Reasonable compensation rule is the issue
Partnership:
( )( )
p
(
Exclusion under IRC Section 1402(a)(13) for distributive share of a limited partner (other than for Guaranteed Payment for services)
44
Schedule K 1 Preparation: Matters to Consider
Schedule K‐1 Preparation: Matters to Consider




Book Capital & tax Capital for Hedge Fund Limited Partners
Partnership Basis
Trader vs. Investor
Investment Interest Expense
45
Schedule K 1 Preparation: Matters to Consider
Schedule K‐1 Preparation: Matters to Consider Allocation of Income and Expenses in a Hedge Fund
Aggregate
Directing Gains/(Losses)
The Layering Method
Incentive Fees
Mark‐to‐Market Elections
Tax Adjustment Basics
Tax Adjustment Basics
46
Polling Word #5
Polling Word #5
• Polling Word #5 is: INCOME
Book Capital and Tax Capital for Hedge Fund Limited Partners
 Distinction Between Book and Tax Capital Accounts  Partners’ book capital accounts reflect the value of each partner’s interest in the partnership. A Partner’s Ending Capital Account Balance (prior), plus Current Contributions, less Current Withdrawals, plus or minus Current Income Allocations, equals the Partner’s Ending Capital Account Balance (Current).
 Tax capital accounts reflect each partner’s investment in the partnership on a tax basis. Generally reflect a partner’s contributed cash amount and the adjusted basis of any contributed property. Thereafter, other allocations that either increase or decrease a partner’s basis will be reflected in the account. t ’ b i ill b
fl t d i th
t
 Tax capital is increased (or decreased) by the amount of net taxable income (or loss) and decreased by cash withdrawn and the adjusted b i f di t ib t d
basis of distributed property.
t
47
Partnership Basis ‐ §705
Basis Increased
Basis Decreased
 Partnership Taxable Income
 Tax Exempt Income
T E
I
 Contributions of Cash
 Contributions of Contributions of
Property
 Increase in Liabilities
 Partnership (Taxable) Loss
 Credits
 Nondeductible Expenses
 Distributions of Cash
 Distributions of Property
p y
 Decrease in Liabilities
 Recourse
 Nonrecourse
48
Trader vs. Investor
“Wh W C ”
“Why We Care”
•
Investment related expenses (including management fees)
– Trader ‐ deductible in arriving at adjusted gross income (as business expenses under IRC § 162)
– Investor ‐ deductible only as itemized deductions (under IRC § 212) ‐ subject to the 2% floor •
Both investors and traders hold securities as capital assets – Capital gains/losses (whether or not the securities are held in connection with his/her trade or business) – Not to be confused with dealers who have ordinary trading income – Traders may make IRC § 475(f) election to mark to market– taxed as ordinary but avoid wash sales, straddles, etc.
• May
May be advantageous to funds with mostly ordinary income from FX or fixed income
be advantageous to funds with mostly ordinary income from FX or fixed income
• May otherwise have complex straddle analyses on partial hedges
• May have eligibility challenged and be subjected to straddle/wash sale/ capital gain/loss matching
49
Trader vs. Investor
Definition”
“Definition
 To determine whether you are a trader the factors considered are: * Taxpayer’s intent; * The nature of the income to be derived from the activity; and * The frequency (must be
derived from the activity; and * The frequency (must be substantial)  “Regular & Continuous”
 Taxpayer’s activities constitute a trade or business where both of the following requirements are met:
the following requirements are met:
 Trading is substantial; and
 Taxpayer seeks to catch the swings in the daily market movements and to profit from these short term changes
movements and to profit from these short term changes rather than to profit from the long term holding of investments. Court will look to how long positions are held.
 Investor ‐ purchases securities to be held for capital h
iti t b h ld f
it l
appreciation and income (dividends and interest), usually without regard to short‐term developments that would influence the price of the securities on the daily market
the price of the securities on the daily market
50
Trader vs. Investor
Empirical Tests
Tests”
“Empirical
• Turnover Ratio
– Consider shorts?
Consider shorts?
• Long Term vs. Short Term Mix
– Doesn’t properly consider tax lot identification effect
– Consider longs and shorts? (shorts are always short term)
• Number of trades per year
– Lumpiness?
– Size of Trades?
– Buys vs. Sells?
• Number of days in the market
– Differentiate between buying days and selling days?
– What if only a buyer? What if only a seller?
What if only a buyer? What if only a seller?
51
Trader vs. Investor
Qualitative Tests
Tests”
“Qualitative
 Amount of time devoted to trading (full time/part time) –
“ ti
“continuous and regular” d
l ”
• Is trading activity exclusive means of earning income (vs. side business)
 Sophistication of investment strategy
 Type of Research
Type of Research
Due Diligence, earnings, financial statements, future outlook, management visits
Technical Data – moving average, short interest, oscillators, hedges
 Use of shorts and derivatives
Use of shorts and derivatives
 Staff and office space  Holding self out as a business – hedge fund vs. personal trading
 Third party management
Third party management
 Earning management fees
Investor Disclosure – holding out as long term “investment” strategy
52
Trader vs. Investor
Final Thoughts
Thoughts”
“Final
 Year‐to‐year determination (status can change year to year)
 Most case law is about day traders – none to date on Investment Partnerships – most cases go against the taxpayer – INVESTOR (most recent case law will be discussed in a later session)
 www.irs.gov/taxtopics/tc429 ‐‐ Topic 429 ‐ Traders in Securities (Information for Form 1040 Filers)
 Last reviewed/updated: December 12, 2013
Last reviewed/updated: December 12 2013
 Massachusetts Draft Directive (issued in May 2011)
 IRS (Market Segment Specialization Program) MSSP Audit Technique Guide (December 2003)
Technique Guide (December 2003
 Focused on issues that fall within sections 701 – 761 of the Code (Subchapter K)
 Subchapter K deals primarily with the formation, operation and termination of partnerships
 Chapter 12, pages 12‐2 through 12‐4; Issue: Securities Traders –
Chapter 12 pages 12 2 through 12 4; Issue: Securities Traders Engaged in a Trade or Engaged in a Trade or
Business? Now (Reserved) per IRS website…
53
Investment Interest Expense
•
Investment Interest Limitation (Code Sec. IRC §163(d) – Trader – rules don’t apply in the case of interest on debt incurred by a trader where the proceeds are used to buy or carry investments used in the trade or business and the partner materially participates (GP); for limited partners IRC §163(d) is applicable
– Investor – interest expense may be limited •
Revenue Ruling 2008‐12 (March 2008) – TRADER ‐‐ for tax reporting purposes, should the partnership separately show the amount of interest expense that it incurred or h ld th
t
hi
t l h th
t fi t
t
th t it i
d
could the interest expense be netted against the partnership’s income?
•
Announcement 2008‐65 (July 2008) – where should an individual limited partner ((that is, a partner who does NOT materially participate in the activities of the partnership), , p
yp
p
p
p),
report the interest expense deduction on his/her tax return?
•
Revenue Ruling 2008‐38 (July 2008) – (1) Investment interest expense deductible to the limited partner only to the extent of their investment income; (2) interest expense will be deductible to the limited partner in the same manner as incurred by the partnership ill b d d tibl t th li it d
t
i th
i
d b th
t
hi
– Trader = Schedule E (“above the line”). Investor = Schedule A (“itemized deduction”).
– What about General Partners (partners who materially participate in the activities of the partnership? If Trader Fund? If Investor Fund?
54
Allocation of Income and Expenses in a Hedge Fund
 Income is usually allocated to a partnership’s partners pro y
p
p p
p
rata, based on each partner’s percentage ownership.
 Specific Allocations: Various partners may be excluded from participating in allocations of certain income and expense items.  Performance Incentive Allocations
P f
I
ti All ti
55
Aggregate ‐ In General
 The partnership maintains an aggregate account (revaluation account) for each partner, where it records the aggregate account)
for each partner where it records the aggregate
amount of each partner’s share of the funds unrealized gains or losses (appreciation or depreciation).
 This allows the partnership to track each partner’s historical interest in the partnership’s unrealized appreciation or (d
(depreciation) without maintaining information on a security‐by‐
)
h
f
b
security basis.
56
Aggregate ‐ In General
Aggregate In General
 As a partnership realizes its prior periods’ unrealized gains and losses, it allocates those realized gains and losses according to the partners’ historical interests in the partnership’s unrealized appreciation/(depreciation), as represented by the revaluation accounts.
 The
The partnership allocates aggregate realized gains or losses to partnership allocates aggregate realized gains or losses to
each partner according to the partner’s aggregate % (the partner’s aggregate balance as a portion of the partnership’s total aggregate balance) or its tax % (economic %’ss adjusted total aggregate balance), or its tax % (economic %
adjusted
for performance allocations), or both, depending on how the partnership’s realized gains or losses compare to the partner’s revaluation account
revaluation account.
57
Aggregate Methodologies (Aggregate with Book Gains, Full Netting)
 The partnership allocates the current period’s book gains (realized + unrealized) to each partner’s revaluation account according to their book percentages
 The partnership allocates realized gain according to the updated (interim) aggregate balances
 The partnership subtracts the partners’ tax allocations of realized gain from their revaluation account balances
58
Directing Gains/(Losses)
Also called “fill‐up” or “fill‐down” or “stuffing”
Permitted in the partnership agreement (LPA); in some cases need to really “look”
cases need to really look for the provision in LPA
for the provision in LPA
Allows partnership to allocate realized gains/(losses) to a Allows
partnership to allocate realized gains/(losses) to a
withdrawing partner in place of unrealized gains/(losses) that a partner would otherwise withdraw
59
Example:
Directing Gains/(Losses)
Directing Gains/(Losses)
Partner
A
B
C
Total
Contrib
$1,000
$1 000
$1,000
$1,000
$3,000
,
Rlzd
$40
$40
$40
$120
U/R
$60
$60
$60
$180
Agg A/C
$60
$60
$60
$180
Capital
$1,100
$1 100
$1,100
$1,100
$3,300
,
Assumptions:
In period 1, the partnership purchased securities 1,2,3. In p
,
p
pp
, ,
period 3, the partnership sells security 3 for a realized gain of $120 and Partner C withdraws from the partnership. The table above shows partners’ capital and aggregate account table above shows partners
capital and aggregate account
balances after period 3 allocations, but before C withdraws.
60
Example: Directing Gains/(Losses)
Directing Gains/(Losses)
Partner
A
B
C
Total
Contrib
$1,000
$1,000
,
$1,000
$3,000
Rlzd
$10
$10
$100
$120
U/R
$90
$90
$0
$180
Agg A/C
$90
$90
$0
$180
Capital
$1,100
$1,100
,
$1,100
$3,300
Rather than allow partner C to withdraw $60 of U/R gains from the partnership, the partnership directs $60 of realized gain to partner C. This reduces partner C’s aggregate a/c balance from $60 to $0. 61
Directing Gains/(Losses)
(Final Thoughts)
(Final Thoughts)
* Character of Gains:
f
 Are realized gains allocated to the W/D partner LT or ST capital gains and how does this jive with how long
and how does this jive with how long they have been in the fund?
** Timing of Gains:
 For example, fully withdraw at 12/31/2013 d
12/31/2013 and are stuffed –
ff d all gain ll i
recognized in 2013; if not stuffed, gain is postponed until 2014
62
The Layering Method
 Requires the income for each security to be allocated to each partner who was a partner in the partnership when the asset partner
who was a partner in the partnership when the asset
was acquired in proportion to that partner’s interest in partnership assets at that time.
 This method was more common prior to the adoption of the Aggregate Method (on 12/21/ 1993).
(
/ /
)
 It is still utilized today in some funds (mostly Investor type I i ill ili d d i
f d (
l I
funds where the trading activity is limited when compared to a typical Trader fund).
typical Trader fund).
63
Incentive Fee Allocation
Incentive Fees
 The fee is a reallocation of income of the limited partners to th
the general partner. l
t
 For book allocation purposes, performance need not be broken out by character of income, for tax purposes all the y
,
p p
components that make up the partnership's performance must be broken out (i.e.; Interest, dividends, realized long‐
term realized short tem etc ) Unrealized is not taxed
term, realized short‐tem, etc.). Unrealized is not taxed.  What results at the end of the tax allocation is every partner’s share of each component of income for the tax year net of any performance fee to be reported on the K‐1s.
64
Mark‐to‐Market Elections
 The §475(f) election is available to traders in securities and should be considered and discussed where most of
considered and discussed where most of the buying and selling of securities by the taxpayer is short term
 The election converts all trading gains and losses (both realized and unrealized) dl
(b h
l d d
l d)
to ordinary income or loss
 Funds (or other taxpayers) that elect mark‐to‐market treatment are not subject to wash sales, straddles, constructive sales, and other complex tax rules
 However, the election effectively However the election effectively
eliminates the potential significant tax benefits of long‐term capital gain treatment and the deferral of any unrealized gains
unrealized gains
65
Polling Word #6
Polling Word #6
• Polling Word #6 is: ELECTIONS
Tax Adjustment Basics: Wash Sales, What is a Wash Sale (IRC Section 1091)?
 A “wash sale” is a sale or disposition of a stock / p
/
security, resulting in a loss, when the seller replaces the stock / security by acquiring or entering into a contract or option to acquire substantially identical stock or securities within a 61‐day period of the original loss (30 days before the sale or disposition + the day of the sale
days before the sale or disposition + the day of the sale or disposition + 30 days after the sale or disposition) (IRC §1091(a)).
(IRC §1091(a)).
66
Tax Adjustment Basics: Wash Sales
How is the sale of a security in a wash sale taxed?
 Gain
G i in a wash sale ‐
i
h l No special tax rules apply. Gain will i l
l
l G i ill
be taxed
 Loss in a wash sale ‐
L
i
h l A loss realized on the stock / Al
li d
th t k /
security may not be recognized for income tax purposes
 Tacked on basis
Tacked on basis
 Tacked on holding period
If the quantity of the stock / security sold at a loss If
th
tit f th t k /
it
ld t l
exceeds the quantity replaced, the loss realized on the excess shares may be recognized as a capital loss for
excess shares may be recognized as a capital loss for income tax purposes (IRC §1091 (b)).
67
Tax Adjustment Basics: Short Sales
Gains and Losses From Short Sales (IRC Section 1233):
 Gains are based on trade date
 Losses are based on settlement date
 General Rule: The holding period of the property used to close the short sale determines the gp
g
holding period of gain or loss
68
Tax Adjustment Basics – Constructive Sales
• The purpose of the constructive sale rule is to prevent investors f
from locking in investment gains without paying capital gains and l ki i i
t
t i
ith t
i
it l i
d
to limit their ability to transfer gains from one tax period to another
 Under 1259, if there is a constructive sale, the taxpayer must;
(1) Recognize gain as if such position were sold, assigned, or otherwise terminated at its FMV as of the date of the constructive sale and immediately repurchased
(2) Make appropriate adjustments in the amount of any gain or loss subsequently realized on the position to reflect the gain recognized on the constructive sale (increasing the basis of the
recognized on the constructive sale (increasing the basis of the AFP)
(3) The taxpayer’s holding period in the position would begin as if p y
q
p
the taxpayer had first acquired the position on the date of the constructive sale (i.e., terminated holding period)
(
)
69
Tax Adjustment Basics ‐ Straddles
 §1092 enacted in 1981 to prevent taxpayers from sheltering income by entering into offsetting positions with no real economic benefit in order to use one leg of a loss in one year and postponing the offsetting gain recognition to another
 A straddle is defined in §1092 as offsetting positions with A straddle is defined in §1092 as offsetting positions with
respect to actively traded personal property
p y
 In other words, a taxpayer holds a straddle when he holds two or more positions in personal property if holding one position substantially reduces the risk of loss from holding the other position
70
Tax Adjustment Basics ‐ Straddles
Straddle Consequences:
Straddle
Consequences:
 Loss Deferral
S
Suspension or Termination of Holding Period
i
T
i ti
f H ldi P i d
 Out‐of‐the‐ Money (holding period unaffected)
 At‐the‐Money (holding period unaffected)
 In‐the‐Money (holding period of hedged stock is SUSPENDED until call is closed out or expires)
 Deep‐in‐the‐Money (holding period of hedged stock is TERMINATED)
Capitalization of Expenses
71
K‐1 Line Placements and Common Footnotes
Schedule K‐1 Line Placement Diff
Differences… Common Schedule K‐1 Footnotes… “It is the things in common that make relationships enjoyable, bit it is the little differences that make them i n t e r e s t i n g .”
.”
― To d d R u t h m a n
72
Overview of Schedule K‐1 Presentations
• Investor – presentations are fairly uniform
–
–
–
–
–
Interest income – line 5
Dividend income – line 6
Capital gains/(losses) – lines 8 & 9
Investment interest expense – line 13H
Oth
Other expenses –
Li 13K (2%
Line 13K (2% portfolio deductions)
tf li d d ti )
• Benefit of deduction may be lost to individual investor
• May not be deductible at the state level
May not be deductible at the state level
73
Overview of Schedule K‐1 Presentations
• Trader: varying presentations – No “portfolio” deductions (not subject to 2% AGI “
f l ”d d
(
b
%
limitation)
– State level deductibility improved since an State level deductibility improved since an “above‐the‐
above the
line” deduction
• Every line item on Line 11F?
• Every line item on Line 1?
• All fund expenses on line 13W?
74
Polling Word #7
Polling Word #7
• Polling Word #7 is: TRADER Common Schedule K‐1 Footnotes
(
(What Do You Mean it’s Nonpassive?)
p
)
Regulation 1.469‐1T(E)(6)(i)
“In general. An activity of trading personal property for the account of owners g
y
gp
p p y
of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity.)”
Some Footnote Examples:
1) Unless
Unless otherwise noted, income from the Partnership is not passive income otherwise noted income from the Partnership is not passive income
for purposes of the Passive Activity Loss rules (Temp. Reg. Section 1.469‐
1T(e)(6)).
2) PLEASE NOTE THAT EXCEPT FOR LINE 1 AND 3, NONE OF THE DISTRIBUTIVE SHARE ITEMS REPORTED ON SCHEDULE K‐1 ARE CONSIDERED AS DERIVED FROM A PASSIVE ACTIVITY UNDER TREASURY REGULATION SECTION 1.469‐
1T(E)(6).
3) THE PARTNERSHIP HAS TAKEN THE POSITION THAT IT IS A TRADER IN SECURITIES. THE AMOUNTS REPORTED ON YOUR SCHEDULE K‐1 ARE NEITHER PORTFOLIO NOR PASSIVE UNDER REG. SEC. 1.469‐IT(E) (6), UNLESS OTHERWISE INDICATED.
75
Common Schedule K‐1 Footnotes
(Box 13 Code H Investment Interest Expense)
(Box 13, Code H ‐
Investment Interest Expense)
Some Footnote Examples:
1
1.
THE K‐1 HAS BEEN PREPARED ON THE BASIS OF A PARTNER WHO DOES NOT MATERIALLY PARTICIPATE IN THE
K 1 HAS BEEN PREPARED ON THE BASIS OF A PARTNER WHO DOES NOT MATERIALLY PARTICIPATE IN
THE OPERATIONS OF THE PARTNERSHIP. THEREFORE, INTEREST EXPENSE HAS BEEN INCLUDED IN BOX 13, CODE H AS INVESTMENT INTEREST EXPENSE AND IS NOT INCLUDED IN BOX 11, CODE F. 1040 FILERS SHOULD ENTER THIS AMOUNT ON FORM 4952, LINE 1. ANY DEDUCTIBLE INTEREST EXPENSE SHOULD THEN BE ENTERED ON SCHEDULE E, PART II, COLUMN (H) (or Schedule A).
O SC
U
,
, CO U
( ) (o Sc edu e ).
INVESTMENT INCOME/EXPENSE ITEMS IN BOX 11, CODE C AND BOX 11, CODE F HAVE NOT BEEN INCLUDED IN BOX 20, CODE A AND BOX 20, CODE B. THESE AMOUNTS SHOULD BE CONSIDERED WHEN PREPARING FORM 4952. PLEASE CONSULT YOUR TAX ADVISOR.
===================================================================================
2. Individual partners that do not materially participate in the operations of the Partnership must report interest expense as investment interest expense on Form 4952, line 1. After application of the limitations of Form 4952, any resulting deduction pertaining to this amount should be entered on Schedule E, Part II, column (h) (or Schedule A). Individual partners that materially participate in the operations of the
column (h) (or Schedule A). Individual partners that materially participate in the operations of the Partnership enter the amount in Box 13 Code H directly on Schedule E, Part II, column (h). The amount reported in Box 20 Code A includes Interest and Dividends (including Qualified Dividends). The amount reported in Box 20 Code B includes the expenses in Box 13 Codes K and/or W. Amounts reported in Boxes 1, 8, 9a, and 11 should be considered in computing your Net Investment Income. p
, , ,
p
gy
Please consult your tax advisor.
76
Common Schedule K‐1 Footnotes
(Box 13, Code W ‐ Other Deductions)
(Box 13, Code W Other Deductions)
• Some Footnote Examples:
1 Part III, Box 13 Other Deductions, Code W ‐‐
1.
Part III Box 13 Other Deductions Code W Other Deductions: Other Deductions:
professional fees, management fees, and other deductions which are related to the Partnership's activity as a trader in securities should be entered by an “individual” taxpayer on Schedule E, Part II as nonpassive.
=================================================================
2. EXPENSES REPORTED ON LINE 13 CODED W ‐ OTHER DEDUCTIONS ARE RELATED TO A TRADE OR BUSINESS AND SHOULD BE REPORTED ON SCHEDULE E FORM 1040 THESE
SHOULD BE REPORTED ON SCHEDULE E, FORM 1040. THESE DEDUCTIONS ARE NOT SUBJECT TO THE 2% OF AGI LIMITATION FOR ITEMIZED DEDUCTIONS.
77
Common Schedule K‐1 Footnotes
(Box 20 Code V ‐ UBTI)
(Box 20, Code V ‐
•
Some Footnote Examples:
1. BOX 20, CODE V: INFORMATION REGARDING UNRELATED BUSINESS TAXABLE INCOME:
YOUR SHARE OF ALL SCHEDULE K‐1 ITEMS OF INCOME/(LOSS) AND DEDUCTIONS OTHER THAN CAPITAL GAINS/LOSSES AND SECTION 1256 GAINS/(LOSSES) THAT IS CONSIDERED UNRELATED BUSINESS TAXABLE INCOME IS:
XXXX
YOUR SHARE OF CAPITAL GAINS/(LOSSES) ON YOUR SCHEDULE K‐1
YOUR SHARE OF CAPITAL GAINS/(LOSSES) ON YOUR SCHEDULE K
1 THAT IS CONSIDERED THAT IS CONSIDERED
UNRELATED BUSINESS TAXABLE INCOME IS:
XXXX
==============================================================================
2. Part III, Box 20 Other Information, Code V ‐ Unrelated Business Taxable Income:
UBTI ‐ Ordinary income (expense)*
XXXX
UBTI ‐ Short term capital gain (loss)
XXXX
UBTI ‐ Long term capital gain (loss)
XXXX
Your share of Qualified Dividends included in
Your share of Qualified Dividends included in
Ordinary income (loss) subject to UBTI: XXXX
===============================================================================
(
f
f
Add to either of the above: (The above amounts should be modified if indebtedness was incurred to acquire your interest in this fund. Please consult your tax advisor).
78
Common Schedule K‐1 Footnotes
(
(Line 19 Distributions)
)
• K‐1 marked “final” in year liquidated (irrespective of when final cash payout is made/received)?
• K‐1 marked “final” in year final cash payment is made/received?
y
p y
Some Footnote Examples (need to read the footnotes):
1. Part III, Box 19 Distributions ‐‐ Gain or Loss on Distribution from the Partnership:
If you made a withdrawal from the Partnership, you may have a gain or loss to
If you made a withdrawal from the Partnership, you may have a gain or loss to recognize outside the Partnership in the year you received the cash distribution from the Partnership. Please note that the withdrawal shown in Box 19 Code A of the K‐1 may reflect distributions that may be received/paid in the following tax year. Pl
Please consult your tax advisor.
lt
t
d i
======================================================================
2. DISTRIBUTIONS
THE AMOUNT REPORTED ON 19A IF ANY OF YOUR SCHEDULE K 1 REFLECTS THE
THE AMOUNT REPORTED ON 19A, IF ANY, OF YOUR SCHEDULE K‐1 REFLECTS THE ACTUAL CASH DISTRIUBUTED TO YOU DURING THIS TAXABLE YEAR. THIS AMOUNT WILL REDUCE YOUR TAX BASIS IN YOUR PARTNERSHIP INTEREST FOR THE CURRENT YEAR. THE TAX RULES RELATED TO PARTNERSHIP DISTRIBUTIONS ARE COMPLEX. PLEASE CONSULT YOUR TAX ADVISOR.
79
Common Schedule K‐1 Footnotes
((Line 19 Distributions – Continued))
Some Footnote Examples (need to read the footnotes):
3. LIQUIDATION
LIQUIDATION OF PARTNERSHIP INTEREST:
OF PARTNERSHIP INTEREST:
IF THIS K‐1 IS MARKED FINAL, THE WITHDRAWAL AMOUNT IN BOX L, REPRESENTS YOUR FINAL CASH DISTRIBUTION IN EXCHANGE FOR THE LIQUIDATION OF YOUR PARTNERSHIP INTEREST. TO DETERMINE YOUR GAIN OR LOSS FROM LIQUIDATION OF YOUR PARTNERSHIP INTEREST, YOUR TAX BASIS SHOULD BE DETERMINED IN ACCORDANCE WITH IRC SEC. 705 AND THE RELATED STATE PROVISIONS. PLEASE CONSULT YOUR TAX ADVISOR.
– REDEMPTION PAYABLE OF PARTNERSHIP INTEREST:
REDEMPTION PAYABLE OF PARTNERSHIP INTEREST:
IF THE ENDING CAPITAL ACCOUNT ON THIS K‐1 BOX L IS MARKED "NONE" AND THE BOX FOR FINAL K‐1 IS NOT CHECKED, THEN THIS K‐1 SHOULD NOT BE CONSIDERED FINAL. YOU WILL RECEIVE A FINAL K‐1 IN THE FOLLOWING TAX YEAR REPORTING THE FINAL CASH DISTRIBUTION RECEIVED IN SUBSEQUENT TAX YEAR. PLEASE CONSULT YOUR TAX ADVISOR.
80
Common Schedule K‐1 Footnotes
(
(Foreign Qualified Dividends)
g Q
)
Footnote Example:
•
FOREIGN GROSS INCOME SOURCED AT PARTNERSHIP LEVEL, BOX 16, CODE D, E:
FOREIGN QUALIFIED DIVIDENDS ARE INCLUDED IN BOX 16, CODE D, E (AS WELL AS IN BOXES 6A AND 6B AND IN BOX 11, CODE F, IF APPLICABLE). PLEASE CONSULT
IN BOXES 6A AND 6B AND IN BOX 11, CODE F, IF APPLICABLE). PLEASE CONSULT YOUR TAX ADVISOR REGARDING WHETHER ADJUSTMENTS SHOULD BE MADE TO THIS AMOUNT OR ANY OTHER AMOUNTS APPEARING IN BOX 16 FOR PURPOSES OF CALCULATING YOUR FOREIGN TAX CREDITS ON FORM 1116.
YOUR ALLOCABLE SHARE OF FOREIGN QUALIFIED DIVIDENDS IS:
XXXX
81
Common Schedule K‐1 Footnotes
(
(State Tax Information)
)
Footnote Examples: (most K‐1s today are issued along with the various State K‐1s…sourcing – resident partners ‐ etc)
1)
FOR INDIVIDUAL PARTNERS:
THE PARTNERSHIP FILED A NYS PARTNERSHIP RETURN WHICH REPORTED NO INCOME FROM NEW YORK SOURCES. THE PARTNERSHIP'S ACTIVITIES ARE LIMITED TO THE HOLDING, BUYING AND SELLING OF SECURITIES FOR ITS OWN ACCOUNT.
FOR CORPORATE PARTNERS:
THE PARTNERSHIP IS A PORTFOLIO INVESTMENT PARTNERSHIP AS DEFINED IN NYS REGULATION SECTION 1‐3.2(A)(6)(III)(D). IN GENERAL, A CORPORATE LIMITED PARTNER SHOULD NOT BE SUBJECT TO TAX IN NEW YORK BASED ON AN INVESTMENT IN A PORTFOLIO INVESTMENT PARTNERSHIP. FOR A CORPORATE PARTNER THAT IS REQUIRED TO FILE A NEW YORK RETURN PLEASE NOTE THE PARTNERSHIP WILL REPORT
PARTNER THAT IS REQUIRED TO FILE A NEW YORK RETURN, PLEASE NOTE THE PARTNERSHIP WILL REPORT BUSINESS AND INVESTMENT INCOME/(LOSS). PLEASE CONTACT THE PARTNERSHIP IF ADDITIONAL INFORMATION IS REQUIRED.
2) State Taxation
Unless otherwise noted, the Fund's activities consist of investing /trading of securities for it's own account. In general, the income generated from these activities, as well as any related portfolio income, is not subject to income tax by most states with respect to amounts allocated to nonresident investors. Please consult your tax advisor regarding the application of this general principle to your situation.
82
Common Schedule K‐1 Footnotes
(Transfer of Property to Foreign Corporations)
(Transfer of Property to Foreign Corporations)
 Form 926
 Transfers of tangible or intangible property to a foreign corporation if g
g
p p y
g
p
a) immediately after the transfer the person holds directly or indirectly at least 10% of the total voting power or the total value of the foreign corporation OR
b) the amount of cash transferred by the person to the foreign the amount of cash transferred by the person to the foreign
corporation during the 12‐month period ending on the date of the transfer exceeds $100,000.
 Form 926 is not required to be filed by the partnership, but by U.S. citizen or resident (individual), domestic corporation, or a domestic iti
id t (i di id l) d
ti
ti
d
ti
estate or trust.
 Each domestic partner of a domestic partnership is treated as making p p
p p y
g
the proportionate share of the property contributed to the Foreign Corporation.
 Property Distributions

Tax basis of distribution
b
fd
b
83
Common Schedule K‐1 Footnotes
(Form 926 – Continued)
(Form 926 –
• Footnote Example:
IRC SECTION 6038B FILING INFORMATION
PURSUANT TO IRC SECTION 6038B (FOR TAXABLE YEARS BEGINNING AFTER PURSUANT
TO IRC SECTION 6038B (FOR TAXABLE YEARS BEGINNING AFTER
FEBRUARY 5, 1999), A PARTNERSHIP'S CONTRIBUTION OF PROPERTY, WHICH INCLUDES CASH, TO A FOREIGN CORPORATION IS DEEMED TO BE MADE BY THE PARTNERS OF SUCH PARTNERSHIP. YOUR SHARE OF FUNDS TRANSFERRED TO THE FOREIGN CORPORATION IS INDICATED ON THE SCHEDULE BELOW. AS A RESULT, YOU MAY HAVE A FILING REQUIREMENT UNDER TREASURY REGULATION SEC. 1.6038B‐1(B)(3) WITH REGARD TO SUCH CONTRIBUTIONS ON FORM 926. PLEASE CONSULT YOUR TAX ADVISOR REGARDING THIS FILING REQUIREMENT.
CONSULT YOUR TAX ADVISOR REGARDING THIS FILING REQUIREMENT.
THE FOLLOWING INFORMATION IS PROVIDED IN ORDER FOR YOU TO COMPLY WITH THE FORM 926 FILING REQUIREMENTS. THE LINE NUMBERS BELOW CORRESPOND TO THOSE ON FORM 926.
84
Common Schedule K‐1 Footnotes
(Form 8621 – PFICs)
(Form 8621 –
• Footnote Examples:
1) PASSIVE FOREIGN INVESTMENT COMPANY ("PFIC') INFORMATION:
ABC VALUE FUND LP INDIRECTLY INVESTS IN PASS THROUGH ENTITIES THAT HOLD INVESTMENTS THAT ARE TREATED AS PASSIVE FOREIGN INVESTMENT COMPANIES ("PFIC")
INVESTMENT COMPANIES (
PFIC ) FOR U.S. TAX PURPOSES. PURSUANT TO FOR U S TAX PURPOSES PURSUANT TO
IRC SECTION 1291 THE PASS THROUGH ENTITIES RECOGNIZED GAIN ON SHARES OF PFICS SOLD AND RECEIVED DISTRIBUTIONS FROM THE PFICS LISTED BELOW.
THE TAX RULES GOVERNING PFIC INVESTMENTS ARE COMPLEX PLEASE
THE TAX RULES GOVERNING PFIC INVESTMENTS ARE COMPLEX. PLEASE CONSULT YOUR TAX ADVISOR REGARDING YOUR FORM 8621 FILING REQUIREMENTS. THESE AMOUNTS HAVE BEEN INCLUDED IN TAXABLE INCOME ON YOUR SCHEDULE K‐1.
THE FOLLOWING INFORMATION SHOULD BE USED TO PREPARE FORM 8621. YOUR SHARE OF GAIN AND DISTRIBUTIONS OF IRC SECTION 1291 NON‐QUALIFIED FUND ACTIVITY IS BELOW.
SECURITY NUMBER OF SHARES
NUMBER OF SHARES DATE ACQUIRED
DATE ACQUIRED DATE DISPOSED
DATE DISPOSED AMOUNT DESCRIPTION
85
Common Schedule K‐1 Footnotes
(Form 8621 – PFICs) ‐
(Form 8621 –
PFICs) Continued
•
Footnote Examples:
2) Information Regarding PFICs That Are Qualified Electing Funds (QEFS)
Information Regarding PFICs That Are Qualified Electing Funds (QEFS)
The Partnership is a domestic partnership and has directly or indirectly invested in one or more Passive Foreign Investment Companies (PFICs) for which a Qualified Electing Fund (QEF) election under Section 1295 of the Internal Revenue Code has been in effect throughout the Partnership'ss holding period. The ordinary earnings been in effect throughout the Partnership
holding period The ordinary earnings
and net capital gain, if any, from each PFIC have already been included in Box 6a and/or 9a of your Schedule K‐1. Either the Partnership or an underlying domestic partnership that owns the PFIC(s) has filed Form 8621 with respect to such PFIC(s). Neither the Partnership nor the underlying domestic partnership that owns the PFIC(s) has transferred stock in any PFIC(s) in a nonrecognition transaction during the taxable year. According to the IRS instructions for Form 8621 (rev. December 2012), based on these facts, a partner is not required to file Form 8621 with respect to QEF(s) owned indirectly via their interest in a domestic partnership. Therefore no further information is being provided about the Partnership'ss QEF Therefore, no further information is being provided about the Partnership
QEF
investments. If a partner wishes to make a Section 1294 election, the information required to make that election will be available upon request. Information about PFICs that are subject to the Section 1291 excess distribution rules, if any, is p
p
reported in a separate footnote to this Schedule K‐1.
86
Polling Word #8
Polling Word #8
• Polling Word #8 is: FOOTNOTES
• For individual viewers, please be sure to click the “Get Your CPE Certificate” button after you submit your final polling word.
Common Schedule K‐1 Footnotes
( Form 8938…)
Form 8938…)
• Footnote Example:
• Form 8938 (Statement of Specified Foreign Financial Assets)
Form 8938 (Statement of Specified Foreign Financial Assets)
IRC SEC. 6038D PROVIDES THAT, FOR TAX YEARS BEGINNING AFTER MARCH 18, 2010, A "SPECIFIED PERSON" HOLDING AN INTEREST IN A "SPECIFIED FOREIGN FINANCIAL ASSET" DURING THE TAX YEAR IS REQUIRED TO FOREIGN FINANCIAL ASSET
DURING THE TAX YEAR IS REQUIRED TO
COMPLETE AND ATTACH FORM 8938 TO HIS OR HER INCOME TAX RETURN FOR THE TAX YEAR IF THE AGGREGATE VALUE OF ALL SUCH ASSETS EXCEEDS THE "REPORTABLE
THE REPORTABLE THRESHOLD
THRESHOLD".. ABC FUND LP IS A PARTNERSHIP ORGANIZED ABC FUND LP IS A PARTNERSHIP ORGANIZED
IN THE CAYMAN ISLANDS. YOUR INTEREST IN ABC FUND LP MAY FALL WITHIN THE DEFINITION OF A "SPECIFIED FOREIGN FINANCIAL ASSET" AND, THEREFORE, MAY GIVE RISE TO A FORM 8938 FILING OBLIGATION FOR TAX YEAR 2012. PLEASE REFER TO THE FORM 8938 INSTRUCTIONS FOR DETAILED INFORMATION AND CONSULT YOUR TAX ADVISOR REGARDING THIS POTENTIAL FILING REQUIREMENT. 87
Common Schedule K‐1 Footnotes
( Other Common Disclosures)
Other Common Disclosures)
1.
U.S. Treasury interest income
• Sometimes you will see additional disclosures as to expenses related to U.S. G
Government Obligations, Costs to Carry U.S. Treasury Obligations, Interest Expense t Obli ti
C t t C
US T
Obli ti
I t
tE
related to U.S. Government Obligations, etc
2.
For Corporate Partners: Dividends eligible for the Dividends Received p
g
Deduction under IRC Section 243:
XXXX
3.
Tax‐exempt interest income – Box 18, Code A or Other Tax‐exempt income – Box 18, Code B
Box 18 Code B
4.
Publicly Traded Partnerships (PTP)
The Fund has direct or indirect investment(s) in Publicly Traded Partnerships (
The
Fund has direct or indirect investment(s) in Publicly Traded Partnerships ("PTP").
PTP ). These These
PTP's are not treated as corporations pursuant to IRC Sec. 7704. As such, distributive share items from these PTPs are included on your schedule K‐1. Investors may be subject to the passive activity loss rules with respect to their investments in PTPs under IRC Sec. 469(k). Please consult with your tax advisor. Income (loss) from PTPs is indicated in the attached
Please consult with your tax advisor. Income (loss) from PTPs is indicated in the attached
schedules.
88
Common Schedule K‐1 Footnotes
( Other Common Disclosures) Other Common Disclosures) ‐ Continued
5. Form 8886 (Reportable Transaction Disclosure Statement)
–
–
–
–
Listed Transaction
Reportable Transaction
bl
i
Notice 2006‐16
Protective Disclosures
6. Form 8865 ‐ Report of U.S. Persons With Respect to Certain Foreign Partnerships
– Report investments in foreign partnerships depending on amount of investment or ownership percentage
ownership percentage.
– Due with return including extensions, if no return is required Form 8865 must be filed separately.
– Categories of Filing
1. Controlled a Foreign Partnership
2. Owned 10% or greater interest during the year
3. Contributed property to a Foreign Partnership during the year
4. Had a reportable event during the year
89
New Schedule K‐1 Footnotes
((Box 20, Code Y ‐
,
Net Investment Income))
• Footnote example(s) – To Be Determined…
** New footnote: Box 20, Code Y: Net Investment Income
Unless otherwise indicated, all of the distributive share items reported on this Schedule K‐1 are subject t th N t I
to the Net Investment Income Tax pursuant to Internal t
tI
T
tt I t
l
Revenue Code Section 1411. Please consult your tax advisor.
90
New Schedule K‐1 Footnotes
((Box 20, Code Y –
,
NII ‐ continued))
•
•
•
Footnote example(s) – To Be Determined… Investor Fund Issue…
** New footnote? PFICs with QEF elections and CFCs…
For 2013, the G election can be made by individuals with direct PFIC/CFC ,
y
/
investments. However, pass through entities can make the election for 2013 only if ALL their partners/shareholders CONSENT to it. If any of these partners/shareholders is another pass‐through entity – the partners/shareholders of that pass‐through entity must consent as well… 
Absent an election otherwise (G election), the NII rules for CFCs and QEFs owned by non‐trader funds subject taxpayers to NII tax only when a distribution is paid out of E&P (as opposed to when the income is included for regular tax purposes).
•
•
While these rules may allow some taxpayers to defer this income for NII purposes, it also adds complexity and an administrative burden because the taxpayer has to keep two sets of records for each PFIC and QEF…
Further, partnerships would have to provide each investor all the information necessary for them to do the calculations at their level
for them to do the calculations at their level Investor Funds – for 2013 – QEF election for NII purposes. – Considering standardized language with respect to the “G election” issue for Investor funds?
Investor funds ‐‐
Investor
funds G election for 2013 –
G election for 2013 – if made at entity level, need if made at entity level need “consent”
consent 

what constitutes consent?
91
Schedule K‐1 Footnotes/Attachments
• Conclusion:
– READ THE FOOTNOTES and ALL ATTACHMENTS
and ALL ATTACHMENTS
– Footnote re: trader status vs investor status
status vs. investor status
• Fund of funds – will have a mix of both investor an
a mix of both investor an trader attributes
92
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