FOR LIVE PROGRAM ONLY Tax Reporting and Reconciliation of Hedge Fund and Other Alternative Investment Fund K-1s Navigating Footnotes and Tying Information to the Tax Return TUESDAY , MAY 16, 2017, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours . To earn credit you must: • Participate in the program on your own computer connection (no sharing) – if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover . • Listen on-line via your computer speakers. • Respond to five prompts during the program plus a single verification code . You will have to write down only the final verification code on the attestation form, which will be emailed to registered attendees. • To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Live Program : -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.
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Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
TAX REPORTING AND RECONCILIATION OF HEDGE FUND AND OTHER ALTERNATIVE INVESTMENT FUND K-1S Suzy Lee, CPA, MST Eliot Goldberg Laura L. Ross, CPA Stacy Palmer, CPA, MBA, MST Withum EisnerAmper Untracht Early egoldberg@withum.com laura.ross@eisneramper.com slee@untracht.com 212.751.9100 415.357.4220 spalmer@untracht.com 973.805.7255 973.805.7147
What is a Hedge Fund? Deconstructing Hedge Fund K-1s Presenters: Suzy Lee, CPA, MST Stacy Palmer, CPA, MBA, MST 5 untracht.com
What is a Hedge Fund? Suzy Lee, CPA, MST 6 untracht.com
What is a Hedge Fund? Hedge funds are alternative investments that may use a number of different strategies in order to earn high returns for their investors. In general, hedge funds use derivatives and leverage their investments in addition to holding the traditional portfolio of stocks, bonds, and cash. 7 untracht.com
History of Hedge Funds Alfred Winslow Jones – first hedge fund in 1949 • • Julian Robertson's Tiger Fund First stars – George Soros, Bruce Kovner • 8 untracht.com
Hedge Fund Strategies Hedge funds use different investment strategies and, thus, are often classified according to investment style. The following classification of hedge fund styles is a general overview: Equity market-neutral • • Convertible arbitrage • Fixed-income arbitrage Distressed securities • Merger arbitrage • Global macro • • Emerging markets • Fund of funds 9 untracht.com
How Hedge Funds are Set Up • Hedge funds are most often set up as private investment limited partnerships that are open to the limited number of accredited investors and require a large initial minimum investment. • Investments in hedge funds are illiquid as they often require that investors keep their money in the fund for a certain period of time known as the “lock - up period”. Withdrawals may also only happen at certain intervals. • Generally, they are not registered under the Investment Company Act of 1940. In general, hedge funds are largely unregulated because they cater to sophisticated • investors. 10 untracht.com
Typical Fees of Hedge Funds • Management fees – compensation for managing the business of the fund - 2% standard figure Incentive fee/allocation – compensation to General Partners for investment advisory • services - 20% of gross returns - High Water marks - Hurdle rates Withdrawal/Redemption fees • Encourage long-term investment 11 untracht.com
General Overview of Investor, Trader and Fund of Funds Presenter: Eliot Goldberg, CPA 12
Overview of Fund Types Trader fund • Seeks “short swing profits” from trading in securities or commodities • Activity is regular and continuous Able to make an election under IRC Sec. 475 • • Reg Sec. 1.469-1T(e)(6) - non-passive for purposes of the passive activity rules 13
Overview of Fund Types Investor fund • Holds investments for longer-term appreciation • Periodic and less frequent trading May hold “investments” other than securities and commodities (i.e. private equity) • • Investments in stocks and securities generate “Portfolio” income and deductions (not passive for purposes of Sec 469) 14
Overview of Fund Types Fund of Funds • Invests in other funds • Characterization of the income and deductions depend on other funds May have its own entity level trading or investing activity • 15
Trader v. Investor • A trader in securities is engaged in the trade or business of trading securities. All items of income and deduction are treated as trade or business income and deductions for federal income tax purposes AND generally, state income tax purposes. • An investor in securities is engaged in activity entered into for profit and all items of income and deductions are treated as investment income and deductions for federal income tax purposes and state income tax purposes. 16
Reporting for Funds Generally, there is a footnote that states whether the fund has taken the position that it is a trader in securities or that certain items are from activities as a trader. May also be discussed in the cover letter. Practitioners vary in their reporting format • Some use box 1 for ordinary income (sec 475) • Expenses may be reported in box 13 code W Interest, dividends and capital gains may be in standard Boxes • Some report trader items (both income and deductions) in box 11 code F • 17
When is a Taxpayer Engaged in the Business of Trading Securities? • There is no definition of trade or business in the IRC • There is no definition in regard to the business of trading in securities in the Federal Income tax regulations • The definition of the business of trading securities has evolved over the last 80 years primarily from case law • While industry professionals often look to portfolio turnover as the litmus test for trader status, there is not one reported decision that describes as a key factor the number of times a securities portfolio turns over during the course of a taxable year One factor is the manner in which an investment manager describes his investment • objective in the private placement offering memorandum There are no reported cases regarding a partnership’s status as a trader vs. • investor 18
Assaderaghi V. Commissioner • The taxpayer was the VP of engineering at a semiconductor company during the tax years 2008 and 2009 • Taxpayer reported wage income of $704,601 in 2008 and $297,869 for 2009. • 2008 Trading Stats: Number of trades 535 (more than half in Jan, June & July) Number / % Trading Days 154 / 61.6% Gross Receipts from Trading $2.659mm Holding period 40% were day-trades; remainder disputed • 2009 Trading Stats: Number of trades 180 Number / % Trading Days 94 / 37.6% Gross Receipts from Trading $349,991 Holding period 19% were day-trades; remainder disputed • Taxpayer’s trading amounts and frequency were not substantial and not frequent, regular and continuous. Penalties sought but NOT imposed (without discussion) 19
Nelson v. Commissioner • The taxpayer was the sole shareholder of a mortgage brokerage company and also actively traded a TD Ameritrade securities account during the tax years 2005 and 2006 • Taxpayer took salary of $266,458 in 2005 and $49,065 from mortgage company compared to trading gains of $470,472 in 2005 and $36,852 in 2006 • 2005 Trading Stats: Number of trades 535 Number / % Trading Days 121 / 48.4% Purchase & Sale Amounts $32.5mm bought / $32.9mm sold Holding period Ranged from 1 – 48 days 2006 Trading Stats: • Number of trades 235 Number / % Trading Days 66 / 26.4% Purchase & Sale Amounts $24.2mm bought / $24.3mm sold Holding period Ranged from 1 – 101 days Taxpayer’s trading amounts were “considerable” but her trading activity was not “substantial” . Penalties imposed! • 20
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