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WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service 1-800-926-7926 x1 (or 404-881-1141 x1) 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. 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 ext.1 (or 404-881-1141 ext. 1). 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. To earn full credit, you must remain connected for the entire program. Tax Reporting and Reconciliation of Hedge Fund and Other Alternative Investment Fund K-1s WEDNESDAY, MAY 16, 2018, 1:00-2:50 pm Eastern FOR LIVE PROGRAM ONLY
Transcript
Page 1: FOR LIVE PROGRAM ONLY Tax Reporting and Reconciliation of ...media.straffordpub.com/products/tax-reporting-and... · 16/05/2018  · TAX REPORTING AND RECONCILIATION OF HEDGE FUND

WHO TO CONTACT DURING THE LIVE EVENT

For Additional Registrations:

-Call Strafford Customer Service 1-800-926-7926 x1 (or 404-881-1141 x1)

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.

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 ext.1 (or 404-881-1141 ext. 1).

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.

• To earn full credit, you must remain connected for the entire program.

Tax Reporting and Reconciliation of Hedge Fund and

Other Alternative Investment Fund K-1s

WEDNESDAY, MAY 16, 2018, 1:00-2:50 pm Eastern

FOR LIVE PROGRAM ONLY

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Tips for Optimal Quality

Sound Quality

When listening via your computer speakers, please note that the quality

of your sound will vary depending on the speed and quality of your internet

connection.

If the sound quality is not satisfactory, please e-mail [email protected]

immediately so we can address the problem.

FOR LIVE PROGRAM ONLY

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WEDNESDAY, MAY 16, 2018

Tax Reporting and Reconciliation of Hedge Fund and Other Alternative Investment Fund K-1s

Suzy Lee, CPA, MST, Senior Tax Manager

Untracht Early, Florham Park, N.J.

[email protected]

Stacy L. Palmer, CPA, MBA, MST, Principal

Untracht Early, Florham Park, N.J.

[email protected]

Laura L. Ross, CPA, Partner

EisnerAmper, San Francisco

[email protected]

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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.

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TAX REPORTING AND RECONCILIATION OF HEDGE

FUND AND OTHER ALTERNATIVE INVESTMENT FUND K-1S

Suzy Lee, CPA, MST

Stacy Palmer, CPA, MBA, MST

Untracht Early

[email protected]

[email protected]

973.805.7255

973.805.7147

Laura L. Ross, CPA

EisnerAmper

[email protected]

415.357.4220

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What is a Hedge Fund? Deconstructing Hedge Fund K-1s

Presenters:

Stacy Palmer, CPA, MBA, MST Suzy Lee, CPA, MST

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What is a Hedge Fund?

Suzy Lee, CPA, MST

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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.

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History of Hedge Funds

• Alfred Winslow Jones – first hedge fund in 1949

• Julian Robertson's Tiger Fund

• First stars –George Soros, Bruce Kovner

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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

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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.

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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

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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

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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)

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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

• Diversified portfolio of uncorrelated hedge funds

• Typically more accessible to individual investors and are more liquid

• Two layers of management fees/ incentive fees

• Transparency may be impaired

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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.

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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

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IRC Section 475(F) Election –Mark to Market (MTM)

• Traders in securities or commodities were allowed to elect MTM accounting for tax

purposes beginning in 1997 (enactment of IRC Section 475(f)

• The statute provides that an election once made, is irrevocable without the

consent of the IRS Commissioner

• At the end of each tax accounting period, taxpayers will MTM all of their securities

in their portfolio and include the gain/loss for the entire accounting period plus

the MTM gain/loss (there are not any unrealized gains/losses) as ordinary

income/loss

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Deconstructing Hedge Fund K-1s

Stacy Palmer, CPA, MBA, MST

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Federal K-1s Trader vs. Investor Status

• Comparative Tax Treatment – Trader vs. Investor

• Examples

- Investor

- Trader – material participation

- Trader – no material participation

- Fund of Funds

• 3.8% Net Investment Income Tax (NIIT) – IRC §1411

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Comparative Tax Treatment:Trader vs. Investor

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Management Fees and ExpensesOther than Interest Expense

• Trader – Expenses are deductible under §162 by individual taxpayers "above the line" in arriving

at AGI.

- Only trader funds can make a §475(f) mark-to-market election (could be just

for some activities within the fund).

• Investor – Expenses are §212 investment expenses, treated as miscellaneous itemized

deductions.

- Subject to 2% of AGI floor limitation and overall AGI-based phase-out of

itemized deductions.

- Miscellaneous itemized deductions are not allowed for AMT.

- Swap expense/loss is treated as a miscellaneous itemized deduction.

- Some states limit or do not allow itemized deductions.

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Management Fees and ExpensesOther than Interest Expense

• Fund of Funds

• The IRS has ruled that all entity level management fees of a fund of funds are §212

investor expenses (Revenue Ruling 2008-39), treated as miscellaneous itemized

deductions subject to the 2% limitation.

• Could have mix of trader expenses depending on investments in underlying funds.

- It is the government’s position that a fund of funds is not considered a

trader, even if solely invests in trader funds.

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Interest Expense

• Trader – materially participates – fully deductible as a non-passive trade or business

interest expense on Schedule E, not subject to investment income limitations.

• Trader – doesn't materially participate – subject to the investment income

limitation, to the extent deductible, treated as non-passive trade or business

interest expense on Schedule E, ordinary deduction.

• Investor – subject to the investment income limitation, to the extent deductible -

report on Schedule A as an itemized deduction.

• Fund of Funds – typically will be mix of investor and trader treatment.

- If fund of funds uses leverage to invest, the interest tracing rules would

apply in determining treatment of interest expense.

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Interest Expense

Example of Trader Footnote (not materially participating)

• "Interest expense has been included in Box 13H as investment interest expense and

is not included in Box 11F. 1040 filer should enter this amount on Form 4952, Line 1.

Any deductible interest expense should then be entered on Schedule E, Part II,

Column (H).”

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K-1 Tips

• If trader fund - ask client about level of involvement in investment.

• Read the K-1 and supporting statements/footnotes carefully!

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Investor K-1s

General Characteristics

• Investment management fees and entity level expenses will be 2% miscellaneous

itemized portfolio deductions in Box 13K – BIGGEST CLUE!

• Investment interest expense reported in Box 13H will be subject to investment

income limitations and be a Schedule A itemized deduction.

• The boxes on the face of the K-1, from Box 1 through to the end, will be completed,

where applicable. In general, usually contains less footnotes (less specific

treatment).

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Trader K-1s

General Characteristics

• Management fees will be a nonpassive ordinary business expense.

• Investment interest expense may or may not be subject to investment income limitations

depending on material participation and will be a Schedule E nonpassive expense.

• Boxes 11F and 13W will be supported by footnote details and Box 11F may include capital

gains/(losses) depending on the Firm preparing the K-1.

Clues in Identifying Possible Trader K-1 in Footnotes

• "Please note that 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).”

• "The K-1 has been prepared on the basis of a partner who does not materially participate in the

operations of the partnership."

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Trader K-1s

• Entity level expenses are reflected under Box 13W.

• If you see 475(f) income under Box 11F (can only make if trader fund). Could either

be trader fund or be invested in a K-1 that has trader fund activity.

• Footnote stating investment interest should go to Schedule E.

• Should always ask client about their level of participation!

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Fund Of Funds K-1s

General Characteristics

• In the view of the IRS, management fees charged by the fund of funds are always

subject to the 2% AGI limitation, however, the character of expenses flowing through

from underlying investments will depend on whether those investments are trader or

investor funds.

• Investment interest expense will be subject to investment income limitations and

may be a mix of nonpassive Schedule E or Schedule A expense.

• The boxes on the face of the K-1, from Line 1 through to the end, will be completed,

where applicable, and lines 11F and/or 13W will have supporting statements.

• Character of income and expenses is preserved for all underlying investments.

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Fund of Funds K-1s

• Potential combination of entity level expenses reflected as 2% deductions under Box

13K and deductions under Box 13W, if invested in trader funds.

• Footnote where investment interest is allocated to both Schedule A and Schedule E

(if invested in trader funds).

• Frequently has items of income and capital gains on face of K-1 and Box 11F (mix of

trader and investor).

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Comparative Tax Treatment of Trader vs. Investor

Status affects deductibility of portfolio expense and eligibility of making Section 475(f)

election as follows:

Trader Investor

Section 162(a) expenses Section 212 expenses - subject to 2% AGI

No interest expenses limitation for partners who

materially participate in the trading activity –

Reported directly on Schedule E as non-passive

deduction

Interest expense limitation under Section 163(d) – Reported

on Schedule A as itemized deduction

Swap expense is not subject to 2% AGI Swap expenses bifurcated from swap income and such

expense is treated as a miscellaneous itemized deduction

Expenses reduce Alternative Minimum Taxable

Income (“AMTI”)

Expenses do not reduce Alternative Minimum Taxable Income

(“AMTI”)

Section 475(f) election No Section 475(f) election

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3.8% Net Investment Income Tax(NIIT) - §1411

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3.8% Net Investment Income Tax (NIIT) - §1411

• §1411(c)(1)(A)(i)

- "Net investment income means the excess of the sum of gross income from

interest, dividends, annuities, royalties, and rents, other than such income

which is derived in the ordinary course of a trade or business not described in

paragraph 2.“

• §1411(c)(2)(B) – Trades and businesses to which tax applies

- "A trade or business of trading in financial instruments or commodities (as

defined in section 475(e)(2).”

Bottom Line

• Net income from trader funds is subject to NIIT regardless of whether or not there is material

participation as the fund is a specified trade or business per the code.

• Income from investor funds and fund of funds are subject to NIIT.

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K-1 Examples

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Footnote Reporting

In alternative investments, footnotes to the federal K-1 provide information that may

have tax implications for different types of investors.

US Treasury Interest

Interest on US Treasury obligations is exempt for individuals for state purposes but is

taxable for federal income tax purposes. The income will be included in Box 5 but a

footnote will provide the amount (a state K-1, if provided, should also report this in

some manner).

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Footnote Reporting - Example

BOX 5 - INTEREST INCOME

U.S. GOVERNMENT INTEREST INCOME

OTHER INTEREST INCOME __________

TOTAL INTEREST INCOME __________

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Footnote Reporting

Muni Interest

Interest on Municipal obligations is not taxable for federal purposes and should be

included in Box 18 Code A.

However, states do not tax individual taxpayers on interest of their resident states (and

US instrumentalities). A footnote will provide the states from which the fund has

earned the Muni interest and provide either amounts or percentages.

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Footnote Reporting - Example

BOX 18, CODE A - TAX-EXEMPT INTEREST INCOME

FOLLOWING STATES:

CONNECTICUT

NEW YORK __________

TOTAL TAX-EXEMPT INTEREST __________

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Footnote Reporting

Expenses related to US Treasury Interest or Muni Interest

For states that calculate tax on a “net income basis”, expenses (interest expense or

other expenses) directly or calculated as “indirectly” related to the income will be

reported in a footnote and the Box on the federal K-1 where the expenses are included.

(State K-1s, if provided, may report these items in various ways either columnar or as

additions/modifications.)

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Differences Between Book and Tax Income on Hedge Fund K-1s & Changes Related to the Tax Cuts & Jobs Act

Presenter:

Laura L. Ross, CPA

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Section L of Schedule K-1

• Items noted in Section L are usually presented on a GAAP basis

― Section L items

― Capital accounts

― Increases/decreases

― Contributions and distributions

• The underlying financials and investor statements of a hedge fund are also stated

on GAAP

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Components of GAAP Income

• Ordinary income items on accrual basis

• Capital items marked to FMV

• Expense items on an accrual basis

• All future costs of liquidating funds

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Differences Between Tax and GAAP

• Amortization periods of organization costs (15 years vs 1 year)

• Dividend Accruals

• OID

• Accrued accounting fees that have not been billed

• Other Differences?

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Adjustments to Tax Itemsand GAAP Differences

• Change in unrealized gains on securities

• Wash sales

• Worthless Shorts

• Constructive sales

• Straddles

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K-1 Income Allocations: Capital Gains

• Several different methodologies can be used to allocate capital gains in an

investment partnership. The most common methods are described in the

Regulations for IRC Section 704(c), and are known as full-netting and partial-

netting. Another method that can be used is known as layering, which tends to be

cumbersome and is not used as often in this environment.

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Example – Typical Book Allocation

500 200 19,000 (1,500) (2,500)

Book Interest Other Total

Own % Interest Dividends Gain Expense Expenses Partner income

GP 0.1 50 20 1,900 (150) (250) 1,570

LP1 0.3 150 60 5,700 (450) (750) 4,710

LP2 0.2 100 40 3,800 (300) (500) 3,140

LP3 0.4 200 80 7,600 (600) (1,000) 6,280

Total Income 500 200 19,000 (1,500) (2,500) 15,700

Sometimes an administrator will present book gain into two components, realized and

unrealized gain. This presentation is not an accurate reflection of the starting tax allocation,

and should be avoided.

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Aggregate Method Qualities

• Not allocated by security

• Susceptible to subjectivity

― Timing of allocations

― Impact of the incentive allocation

― Timing of tax adjustments

• Qualifications for use

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K-1 Income Allocations: Full-Netting

A and B form a partnership with each

contributing $100,000. The partnership

buys two stocks. During the course of

the year those stocks go up in value so

that each partner has a book capital

account of $125,000.

Tax Unrealized Book

Basis Gain Basis

A 100,000 25,000 125,000 B 100,000 25,000 125,000

200,000 50,000 250,000

Original Increase FMV of

Investment in Value Investment

NOK 100,000 20,000 120,000 SGP 100,000 30,000 130,000

200,000 50,000 250,000

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K-1 Income Allocations: Full-Netting

Partner C enters in the next period, and

contributes $125,000, so all three partners

have the same book capital accounts.

Additional stock is purchased, and book

value goes up another $30,000.

Tax Unrealized Book

Basis Gain Basis

A 100,000 35,000 135,000

B 100,000 35,000 135,000 C 125,000 10,000 135,000

325,000 80,000 405,000

Original Increase FMV of

Investment in Value Investment

NOK 100,000 20,000 120,000

SGP 100,000 30,000 130,000 IBM 125,000 30,000 155,000

325,000 80,000 405,000

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K-1 Income Allocations: Full-Netting

The partners decide to sell SGP at this

point, which has an unrealized gain of

$30,000 – when sold this becomes

taxable income. What is the most

logical way to allocate the $30,000 gain

among the three partners?

Tax Unrealized Book

Basis Gain Basis

A 100,000 35,000 135,000

B 100,000 35,000 135,000 C 125,000 10,000 135,000

325,000 80,000 405,000

Original Increase FMV of

Investment in Value Investment

NOK 100,000 20,000 120,000

SGP 100,000 30,000 130,000 IBM 125,000 30,000 155,000

325,000 80,000 405,000

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K-1 Income Allocations: Full-Netting

The most logical way to allocate the

gain is by the amounts of unrealized

gain each partner has. This is the

basis of the full-netting concept, and

it is identified in Regulation 1.704-3.

Unrealized Realized Remaining

Gain Gain Unrealized

A 35,000 13,125 21,875

B 35,000 13,125 21,875

C 10,000 3,750 6,250

80,000 30,000 50,000

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K-1 Income Allocations: Partial-Netting

Partial-netting is very similar to

full-netting. The difference is the

gains and losses are allocated

separately. This method may

reduce disparities faster than full-

netting can.

Tax Unrealized Book

Basis Gain Basis

A 100,000 30,000 130,000

B 100,000 30,000 130,000

C 125,000 5,000 130,000

D 135,000 (5,000) 130,000

460,000 60,000 520,000

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K-1 Income Allocations: Partial Netting

Assume we are allocating $30,000 in

realized gains again, but that amount is

composed of $34,000 of gain and $4,000 of

loss. Loss is first allocated to the partner

with unrealized losses, gains are allocated

to the partners with unrealized gains.

Unrealized Allocation Remaining

Gain Unrealized

A 30,000 15,692 14,308

B 30,000 15,692 14,308

C 5,000 2,616 2,384

D (5,000) (4,000) (1,000)

60,000 30,000 30,000

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K-1 Income Allocations: Layering

Layering is the most precise method, but

also the most cumbersome. The periodic

appreciation or depreciation of each

stock tax lot must be tracked

simultaneously with each partner’s

ownership percentage for each period.

When the stocks are sold, each partner

receives their exact portion of

appreciation or depreciation for each

stock.

This method is not commonly used due to

the amount of record keeping necessary.

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Wash Sales Overview – Section 1091

• A wash sale occurs when

― A loss is sustained upon the sale or disposition of stock or securities,

― And “substantially identical” stock or securities are acquired either 30 days

before or 30 days after the date of sale (the 61-day window).

― Or a contract or option to acquire substantially identical stock or

securities is purchased

• Treated “as though” you just held the original securities

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Purpose of the Wash Sale Rules

• To prevent taxpayers from artificially recognizing tax losses while maintaining

their holdings in the stock or securities sold.

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Tax Consequences of Wash Sales

• Pursuant to Section 1091(a), the loss is not allowed to be recognized at the

time of the sale.

• Pursuant to Section 1091(d), the disallowed wash sale loss is added to the

basis of the substantially identical stock or securities, the purchase of which

resulted in the wash sale.

• Holding Period of Replacement Stock or Securities — The holding period,

under Section 1223(3), includes the holding period of the stock or securities

that was disposed of at a loss. In other words, the holding period is “tacked

on.”

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Constructive Sales Overview – Section 1259

• A Constructive Sale occurs when:

― A taxpayer holds an “appreciated” position in a security

― And acquires an “opposite” position in the same or substantially identical

security.

• Treated as though you sold the appreciated securities on that date, and bought

them right back.

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Purpose of the Constructive Sale Rule

• To prevent taxpayers from reducing their exposure to the stock or securities while

artificially deferring the recognition of tax gains.

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Constructive Sales Rules

• Treated as if the original position were actually sold.

― Recognizes gain only.

― Does not apply to losses.

― End old holding period and start new holding period as of constructive sale

date for original position. Therefore when you sell the original position, the

date of the constructive sale is deemed to be the date on which the position

was acquired.

• Non-Convertible Debt Instruments are exempt from the Constructive Sale Rule

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Changes Related to the Tax Cuts and Jobs Act

• Impact to General Partner

― 3 year look-through rule for long-term capital gains received from carried

interest.

― No guidance available yet on implementation

― Initial language that would have made S-Corps exempt from the rule has been

overridden by new guidance

• General Partners with lower management income may be able to get some

advantage from the new qualified business income pass-through deduction

― In general, this deduction is not available for those who provide investment

advice, but there is an exception for lower income amounts.

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Changes Related to Tax Cuts and Jobs Act –Pass-Through Entity Deduction

• Starting 2018 tax year, taxpayers who have domestic “qualified business income” (QBI)

from a partnership, S Corporation, or sole proprietorship are entitled to deduction of the

lesser of such QBI or 20% of taxable income over the net capital gain.

• The deduction reduces taxable income, not adjusted gross income at the individual level.

• The 20% deduction is also allowed for a taxpayer’s qualified REIT dividends, qualified

cooperative dividends, and qualified publicly traded partnership income.

• QBI is net amount of qualified income, gain, deduction, and loss with respect to any

qualified trade or business (i.e. US effectively connected income) of the taxpayer. It

includes income other than investment income (e.g. dividends, investment interest income,

short-term capital gains, long-term capital gains, commodities gains, foreign currency

gains, etc.)

• QBI is limited to the lesser of

i) 20% of the taxpayer’s QBI or

ii) the greater of 50% of the W-2 gages with respect to the qualified trade or business or

the sum of 25% of the W-2 wages plus 2.5 % of the unadjusted basis of all qualified property

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Pass-Through Entity Deduction

• The deduction expires after December 31, 2025

• Taxpayers with pass-through income from specified service businesses in the fields of health,

law, accounting, consulting, financial services, and brokerage services are not eligible for the

deduction.

• Neither “W-2 wage” limit nor the prohibition on specified services businesses applies to a

taxpayer with taxable income not exceeding $157,500 ($315,000 in the case of a join return).

• These limitations are fully phased in for a taxpayer with taxable income in excess of the

threshold amount plus $50,000 ($100,000 in the case of a join return).

• The calculation of the pass-through entity deduction and related wage and capital limitation

is done for each trade or business. If a taxpayer has multiple interests in pass-through entities

and each pass-through entity is in a qualified trade or business, such taxpayer will need to

keep track of the trade or business income separately.

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Pass-Through Entity Deduction

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Changes Related to Tax Cuts and Jos Act -Limitation on Losses from Partnerships

• Starting 2018 tax year, excess business loss of a taxpayer of a partnership will be

limited.

• An excess business loss for the tax year is the excess of aggregate deductions of the

taxpayer attributable to trades or business of the taxpayer, over the sum of aggregate

gross income or gain of the taxpayer plus a threshold amount ($500,000 for married

taxpayers filing jointly; $250,000 for all other taxpayers (indexed for inflation)).

• Limitation at the partner level.

• The excess business loss is treated as part of the taxpayer’s net operating loss (NOL)

carryover to the following year (subject to 80% of taxable income limitation). The

limitation applies at the partner level.

• The limitation expires after December 31, 2025.

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Changes Related to Tax Cuts and Jobs Act -Sales of Partnership interest with ECI

• Rev. Rul. 91-32 re-established gain or loss from the sale of an effectively connected

income (ECI) partnership interest by a foreign partner is treated as ECI.

• Applies to sales or exchanges on or after November 27, 2017.

• 10% withholding on sale of non-publicly traded partnership. 10% withholding on sale

of PTP is suspended for now (Notice 2018-8) but not for non-PTP.

• Purchaser or transferee must withhold 10% of the realized on the disposition absent

certificate from seller. (i.e. If the transferor furnishes to the transferee its US ID

and an affidavit certifying that it is not a foreign person signed under penalties of

perjury, withholding is not required.)

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Changes Related to the Tax Cuts and Jobs Act

• Impact to Funds – Investor Funds

― 2% Deductions

― 2% deductions are no longer deductible as of 2019. Management fees and

accounting and legal expenses will not longer be deductible by partners of the

fund, which will significantly decrease effective return.

― In light of this change, there will be increased pressure to qualify as a trader

fund.

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Changes Related to the Tax Cuts and Jobs Act

• Impact to Funds – Trader Funds

― Interest Expense Deduction

― Interest expense deduction will be limited in a given year to business interest

income plus 30% of “adjusted taxable income” which will be determined by a

formula based upon EBIT.

― Leveraged funds could find interest expense not deductible in certain years

― Does not apply to businesses with gross receipts of less than $25 million

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QUESTIONS?

Suzy Lee, CPA, MST

Stacy Palmer, CPA, MBA, MST

Untracht Early

[email protected]

[email protected]

973.805.7255

973.805.7147

Laura L. Ross, CPA

EisnerAmper

[email protected]

415.357.4220

96


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