Year-End Tax Planning Webinars for Funds and GPs | Part I

Irina Kimelfeld: Thank you, Simcha, and welcome everybody. We will kick off with, there we go. We'll kick off with hedge fund considerations for year-end as you are reviewing your portfolios and reviewing your results for the year. A few things to look at and consider and refresh your memories on some of the common tax adjustments that we look at for in the hedge fund space. So obviously reviewing your year-to-date taxable income and seeing where it is in relation to your book income, you can anticipate where you are and what is the taxable position you're planning on reporting to your LPs and you consider making any trading decisions that you still have time to make if where you currently are is not where you would like to be. Some of the common tax adjustments that we need to consider as you are planning these year-end trades and are looking at your portfolios and also are thinking about what your taxable income looks like.

One of the most common one is wash sales. As a refresher, what wash sales are is the losses are not allowed on the security if substantially identical securities purchased within 30 days before or after the date of sale. And when we say substantially identical security, it's not just purchasing the same security but also entering into contracts or options to buy a substantially identical security. So the most common question that we get is, well, if we really want that loss, we really want to take that loss, but we don't necessarily want to completely exit the exposure to the investment, is there anything that we can do?

So the wash sale rules are really there to prevent exactly that. The idea being that if you are going to take the tax benefit of a tax loss, you should not be economically exposed to the position to the investment. So that's the reason why the rules are there and this 30 days window that's in the rules is really there kind of thing. If you go back into the security, it's as if you've never really taken the loss economically. So we're not going to let you take the loss for tax.

But there are still some ways where you may not be perfectly aligned in the exposure but it gets you close enough to where you'd be able to take the benefit of the loss on the tax side, but still maintain at least some exposure to the original position. So probably the easiest one is the doubling down, it's the second one on the bullet point there. And that's really, you're exposed effectively twice and so you're able to take the loss but you've already purchased it, but for a period of time you're holding the security twice. So you're not in the exact same position if you would've just been able to sell and then buy back.

You really have to hold onto so the security twice and then sell one of the positions and take the loss. The other one is a basket swap. So basket swap is you sell your original security, you have a loss on it, and then you go into a basket swap contract which is, it has to be composed of at least 20 positions including the position in the original security that you took the loss on, but you're putting other securities around it. So it's a basket of securities. The original security cannot constitute greater than 70% of that basket at the time when the basket contract swap is purchased. So once again, you're not going to have the exact same exposure, because you're being exposed to other securities around the original position, but it still gets you the exposure to that original position while being able to take the loss.

Simcha David: It's nice, Irina, that we're talking about the doubling down when there's, I believe still time to do the doubling down. I think one year, we started in December our year-end tax planning and so that was a little difficult to do, but so that-

Irina Kimelfeld: So you still have that 30 days before year-end when you're able to do that. And the last potential way to be able to take the loss, but still continue to be exposed is introduction of an option. So you have a sale, you go into a call option which would constitute a wash sale and then you purchase the same security, because you've already had the original security washed, that subsequent purchase is not going to constitute the wash sale and then you exit out of the option and the exit out of the option it results in that same loss because when we say the wash sales are disallowed, they're not permanently disallowed. What happens is the loss that you're not able to take on the securities added to the basis of the transaction that caused the wash sale.

So the basis is added to your option. When you get out of the option, you then take the loss. So you're intentionally triggering the wash sale before actually purchasing the security that you really want to be holding. So some of these techniques, like Simcha sort of mentioned, you need to figure out what your timing is. You do need to measure your 30 days, so you need to have time to do it. But if you're looking at your portfolios and you already know you have wash sales, if you have significant wash sales in the portfolio, that can drastically change where your taxable income potentially versus your book income is. You don't want to have surprises there. So if you go through the analysis now and realize that you do have quite a bit of wash sales, it is something to potentially plan around and see what can be done and if you do want to potentially exit out of the positions that have created wash sales and then continue managing your portfolio between now and year-end. The other-

Simcha David: For many people on the webinar that do a lot of trading, they may not realize how large a wash sale loss has been generated to want to get out of it. And so it's important to take a look at that if you can prior to year-end so that you know what you're trying to solve for.

Irina Kimelfeld: So we do have quite a number of clients who are coming to us now asking us to run wash sale reports if we're helping them with that analysis or they're going to their administrators who run the reports for them. But it's a helpful exercise to know where you are vis-a-vis analyzing your overall taxable situation. The other in the realm of holding offsetting tax positions. The other tax adjustments to pay attention to is the straddles. And tax straddles, sorry, are defined as holding offsetting position in actively traded personal property such as long and short on the same stock, basically. But it doesn't have to be just long and short on the same stock, it's really any offsetting position that provides substantial diminution of risk of loss.

And the impact of the straddle is that if you have a tax straddle and one leg of that straddle, so you have two legs offsetting positions and one leg of the straddle is disposed of at a loss, but the other leg is continuing to be held presumably at a gain, because that's if there are offsetting positions that provide diminution of risk of loss, when one depreciates the other appreciates. So the disposition of the loss leg, the loss will be disallowed until the gain leg is disposed of. So you can be in a situation where you get to the year-end and the losses that you've realized are disallowed as long as you're continuing to hold that offsetting position. And that can be once again, potentially cause for a surprise and a large book tax difference resulting in higher taxable income vis-a-vis what your economic, your book income is to the investors.

Simcha David: And of course I think a major difference obviously between the wash sales and the straddles is wash sales is substantially identical, which gives you a lot more leeway in terms of how you could still have exposure versus with straddles where it's anything that's substantial diminution for the risk of loss. So it will substantiate identical. It's not the same standard.

Irina Kimelfeld: Thank you. And the other one that I wanted to kind of go through is constructive sales, because we actually had a couple of clients recently come to us and where they ended up in that situation sort of once again unwittingly. So the constructive sale is kind of the flip side almost of a straddle and that is if you are entering into an offsetting position when you are holding an appreciated position and basically the logic, I guess if there's logic to tax rules there is that if you have terminated your economic exposure to a position, but you've done it sort of synthetically by entering into an offsetting position, the IRS wants you to recognize that gain. So there are two ways to have a gain to lock in your gain. One is you obviously sell out the position, you take your gain and pay tax on it, but the other way is you enter into an offsetting position which once again is going to move in tandem.

So to the extent that your appreciated position goes down, your offsetting position goes up and vice versa. So you've effectively locked in whatever your economic gain was by entering into an offsetting position. So now you have to recognize a gain for tax that you haven't realized. So the most sort of common way to get into a constructive sale, but by no means the only one is entering into a short against the appreciated loan. And vice versa, you can have an appreciated position that's a short position, so acquiring the stock would also result in a constructive sale.

The positive to all that, unless the constructive sale is really being done on purpose is that you have some time to be able to unwind so you don't have a constructive sale and that gives a little bit of leeway to see maybe where the market is going and do you really want to take the gain and sort of decide, gives you time. So if you have entered into constructive sale by entering into an offsetting position, to an appreciated financial position, you have until 30 days after year-end. So that would be, and it's 30, it's not a month, so it would be until January 30th, 2025 to unwind. So in the classic example where you have long stock and you enter into a short, you have until January 30th, 2025 to unwind the short and then you don't have to recognize that gain for 2024. The sort of catch here is that if you're using this exception I guess to the constructive sale rules of 30 days, then you have to continue holding unhedged that original position for 60 days after the unwind.

So if you do the math, we as tax preparers would not really know if you've had a constructive sale, if you had a potential constructive sale in 2024, you then say, okay, I'm going to really unwind it so I'm going to unwind it by January, 29th, let's say. Well then we have to wait for 60 days from there to see. So it takes us into March to confirm that that original position, that original appreciated position was still held in March of 2025 before we can definitively say that you in fact did not have a constructive sale. But it gives people some room to decide whether they want to take the gain if this was sort of intentional or really unwind the transactions or whether they're okay with taking the gain. And that could be also determinative of what the overall position of the fund is, what the overall taxable income looks like and give some indication of what we want to do with the transactions. There are obviously holding period implications because when the security is constructively sold, it is treated as in fact being sold. There's no more holding period there.

And some of the other things that... I think that's what I wanted to say. Some of the other things that we would encourage our clients to do now is the trader versus investor analysis. So it's really depends on what the strategy of the fund is, but if the strategy of the fund has historically been a trader, and just as a reminder what the implications of trader is that the expenses of the fund are considered active expenses, they're treated as trader business expenses and therefore not limited or not disallowed really at the investor level and to be treated as a trader for tax purposes, once again for tax purposes, because most of our clients will tell you, "Well, I actively trade." So having this conversation of well are you a trader or an investor is very sort of difficult because from the tax perspective that could look very different than from more of purely activities based perspective.

But to qualify as a trader for tax purposes, the activity of trading has to be regular and continuous and we don't really have anything in the code that tells us what that means, but it's defined in a number of court cases and it's a pretty high bar to get to that trader business of a trader classification. You generally would have to trade for vast majority of available trading days, you have to have high portfolio turnover. We generally say at the very least three times we'd like it to be higher, there has to be a high number of trades and when we say high number of trades, we're talking about into the thousands, which is once again if you're really trading for majority of the days, that can get there.

So we have clients that are very clearly a trader, just really high volume, thousands of trades, multiple turnovers. And then we have clients that are any type of fundamental investing fund would generally we would expect them to be in the investor bucket. They're really trading sort of deliberately, they hold onto to their investments for long-term periods. So those are really not traders. One of the other hallmarks of being a trader is that vast majority of gains and losses are short-term or hyper short-term gains and losses.

Simcha David: Very interestingly, Irina, to that point exactly is when clients sometimes say, "Well, I'm doing a lot of trading." They kind of pushing us to try to get to that trader analysis and you look at their PPM and the investment objective says the investment objective of this fund is to gain long-term appreciation in our securities. That's the first place the IRS is going to go to. So sometimes you just got to be careful what you've put into your documents as your investment thesis. You may think you're in the market all the time, you may think you're doing a lot of trading, but ultimately as you said, Irina, it's a bunch of factors that go into it. But primarily is that most of it's going to be short-term versus long term.

Irina Kimelfeld: And no real one factor is determinant. So in Simcha's example, if that's what's in the PPM, that's not a great factor, but if the actual activity is really indicative of a trader from a tax perspective, we can still go there. You possibly want to talk to the attorney-

Simcha David: You may want to change your documents.

Irina Kimelfeld: about where your PPM needs to be. Maybe you're not describing your strategy quite accurately, but from a tax perspective if the activity's there, we'll go there. But if the activity's not there and there's lots of long-term capital gains or dividends or interest, which generally would indicate that once again the investments are being held longer term, long enough to get that dividend income, then it's all the combinations of factors done together.

So if a fund has historically been a trader, we're still encouraging clients to go back and look at this analysis, especially if you weren't quite as clearly in the trader camp but weren't clearly the investor camp either. So it's really sort of an annual conversation about the fund then now is the time to really go back in and look what does that analysis look like? It's not common for funds to sort of come in and out of one status or the other.

We definitely would not expect it specifically because there's usually an investment thesis and that investment thesis will not align with either a trader or an investor for tax purposes. But there are funds that do intend on short-term trading but maybe haven't had the markets, whatever it is they're trading, the markets weren't quite there for them to get to that high volume and the turnover. But there are probably things that can still be done if you really want to bolster that trader trader classification to make it clearer that you were in fact a trader during the year and get over that finish line. But once again, trying to avoid surprises after year-end when we go through the analysis and say, well, this now becomes a risk factor if we're going to continue treating you as a trader, but the facts are not quite there.

Simcha David: And there may be a little bit of the fund is winding down that historically was a trader. There may be a little bit of leeway in that last year to say we're not going to change to investor even though some of the training has gotten less if the fund is winding down. So just putting that out there as well.

Irina Kimelfeld: And the last one is section 475(f) elections. If we're seeing it in new funds that launch that intended to be section 475(f) funds. So the first prerequisite to make the election is that you are a trader. That the activity and if it's a brand new fund, the activity is clearly intended to be a trader even if maybe you didn't quite get there the first year, but your investment thesis and your activity kind of is on the ramp up to that trader. But to starting point to making a 475(f) election is you have to be a trader. You can't make an election if you're not one or if you do make it, it's presumably invalid. But assuming that the fund is a trader, the 475(f) election, what the fund is electing into is saying we are going to treat all of our income as ordinary income or loss and with that comes that everything's going to get marked to market.

At the end of the year, everything is treated as if sold. So you're treating all the income as ordinary and so there's no possibility for long-term gains here. But if we go back to that original discussion of what's a trader, a trader really is not expected to have long-term capital gains anyway so ordinary is not sort of, you're not effectively giving anything up. You would get ordinary losses if you're in a loss and the fact that you're marking everything to market at the end of the year eliminates the need for all of that other tax analysis that we talked before. There's no wash sales, because realize the unrealized, we're taking all the losses and gains on everything. There's no straddles, there's no straddle analysis, there's no constructive sale analysis because you are treating everything as constructively sold at the end of the year. So those are kind of the trade-offs. So we have seen a number of funds that we're launching and in their documents and in all the discussions they said, well, we're going to make a 475(f) election. That's what we're going to do.

Which is great, but there are sort of affirmative steps that do have to happen to make the election. So if it's a newly launched fund, there has to be an election made in the books and records within a certain period of time of starting trading and if it's an existing fund that is trying to make this election that hasn't had it before, the election really has to be made prospectively. What that means is that now that we're 2024 and unfortunately there's a bunch of unrealized losses, it's too late, we can't make the election for '24 anymore.

The next opportunity to make the election is for '25 and that election has to be made with the extension of the 2024 return. So presumably in March of 2025. So the idea is that you don't have time, the fund doesn't really have time to pick and choose its character. So in the beginning of '25, the fund presumably doesn't know what character of income it's going to have, whether it's going to be up or down for the year. So if the fund wants to make the election, they can make it, but it really has to be prospective. But if the intention was always there, then that election does have to get attached to the extent that election has to be attached to the extension that's going to be coming up in March of '25.

Simcha David: And just to make it clear, it doesn't have to be done in the first year of the fund. If the fund goes a couple of years as a trader without a 475(f), it can make it as you said, as long as it does it prospectively. And then on top of that, the gain that does come from the mark to market, it doesn't have to be picked up all at once, it can be picked up over four years. There's a process to it, but it's available for anybody that's a trader. So just because you haven't made it right away, don't think that it's not available for you.

Irina Kimelfeld: But I think what we're seeing is that initial step of for the first year funds, of that initial step of having a books and records election, that can be demonstrated that it was dated at the appropriate time and then attached to the extension for the '24 return. So the only people who could make '24 elections even maybe now are the funds that are launching now. All right, next polling question.

Bella Brickle: Poll #2

Irina Kimelfeld: And just I guess a general disclaimer, the techniques that we talked about and there's some others that are out there, definitely do consult with your specific tax advisers who understand your portfolio, your trading, and what you're trying to accomplish. So this isn't sort of go and do it on your own. If it hasn't been part of your trading strategy in the past, do speak to your tax advisers.

Irina Kimelfeld: Okay, 70% will be using the techniques. That's great.

Simcha David: Very interesting.

Irina Kimelfeld: That is very interesting. Okay, I'll spend a few minutes just to give everybody else time to speak on some management company and GP considerations. Probably one of the bigger things that we're talking in the management company realm is self-employment limited partner exception, which is historically we've had a number of management companies that are structured as limited partnerships taking the position that the share of income that is being allocated to the limited partners in the management company is not subject to self-employment income tax. Self-employment income tax consists of social security and Medicare. Social security is generally capped at a number that goes up every year, but somewhere in the $160,000 realm. And then the Medicare tax is uncapped or on uncapped income. So like I said, historically limited partners have taken, because in the code there is in fact an exception to the income that is subject to self-employment tax and that is income that is earned by limited partners as such.

And the reason I say as such is because it became a very important two words in the last year. So the code tells us that limited partners do not have to pay self-employment tax on their share of partnership income and that is what management company partners have done for years and the IRS has always sort of had a, for a long time has had issues with it in that they sort of questioned what is really limited partner and are those the limited partners that were intended to be included in the exception in the code? And there have been a number of cases that have come up and they weren't necessarily in the investment management realm and they weren't necessarily with LPs.

Well, at the end of 2023, Soroban case was decided and it was specifically on point in that it was an investment management firm, it was an asset manager, it was an LP structure and the tax court basically said that they really sent it back. All they really said is that we're not going to tell you that your income is not subject to self-employment tax summarily. What you really have to go back to and think about whether under a functional analysis, when we analyze the activities of these limited partners, whether they're really limited partners and if they're not really limited partners then all of the income would be subject to self-employment tax.

Simcha David: And, Irina, just because we had so many discussions of this altogether correctly stated and that was the big issue, because the attorneys asked for summary judgment on a limited partner, part because this was a real limited partnership and the code says limited partner, so why are we even discussing a functional analysis? I'm a state law limited partner, that should be enough. And that's why it's kind a win for, but it's again, only in tax court but it's kind of a win for the IRS because they said they read into the code limited partner as such that somehow those words as such means that they don't mean a stable limited partner, that it could be subject to a functional analysis as we had in other earlier cases in the et cetera.

So that's kind of what everybody was hanging their hat on, limited partner. It says limited partner, it means limited partner, it means a state law limited partner regardless of what I do and now the tax court seems to be moving away and ultimately where that will end up, will it get challenge? So that's where everybody is currently on that. But the IRS position has always been, like you said, they didn't like this idea.

Irina Kimelfeld: And so is the Soroban case is kind of further along. The parties have filed briefs defending why they are not, obviously the taxpayer defending why they should not be subject to self-employment tax and why they really should be respected of limited partners and IRS arguing why functionally they are not limited partners and therefore would not be subject to the exception.

Simcha David: And to that point as well, I'm sorry, I love talking about this stuff, but to that point as well, just because the tax court said you have to do a functional analysis doesn't mean that the way people have structured or attorneys have structured these limited partners, it has to be an all or nothing. The IRS has always taken a position, you're either limited or you're active. There's no such thing as bifurcating and saying, "Well, I'm taking a salary for my activity but I've also got all this appreciation that should be non-active so to speak and it should come to me as my distributor shares limited partner." So that's where the briefs are coming in and saying, yeah, but we may be active somewhat but we're getting compensated perhaps or maybe they're just going to try to say that they're not as active as they seem, but obviously people are active. So that's part of the question, which is what the court is ultimately going to have to decide. Is it an all or nothing? Is there something in between? What's going on? Remains to be seen.

Irina Kimelfeld: That's correct. There is another asset management firm that is basically going through the same process. They were a little bit behind Soroban, but that's winding its way through the courts as well. It's called Denham Capital Management. So same issues also NLP and that's in tax court if you guys wanted to pay attention to the jurisdiction because in the Fifth Circuit court, a non-asset management firm and actually not an NLP, it's LLP, Serious Solutions, they're an advisory firm has asked the court, they're going through their own assessment, but they have asked the courts to reverse Soroban. Exactly on that point, as Simcha pointed out, that the functional analysis really should not apply here because as state law limited partners, the statute covers it. So that is really probably really the biggest item that we're watching and we're paying attention to and we're talking to our clients about.

The other one I'll just mention really quickly for the GP considerations on the hedge funds since we're talking about hedge funds, is if are taking carry, 1061 is still out there and that's the code section that reclassifies income from sales on property health for one to three years as short-term for the carry recipients. This is just a reminder that if you have that income, if you are taking that carry, for the income to be, the return on that income, once your carry is crystallized, if you're keeping it in the fund, you need to segregate it out.

The GP counts need to segregate it out of the fund so that you're not continuing to be subject to carry on the return on that capital. So if you're leaving the carry in the fund, that can turn into your contribute to capital, but it does need to be segregated out. So if that hasn't been your practice, it's just a reminder to go back to your service providers and make sure that your carry is getting segregated out so the earnings on it can be treated as long-term as long as they're over one year. I'm going to now turn it over to Estee to talk about some of the private equity considerations and we'll start with workforce securities.

Estee Kushner: Thanks, Irina. Yeah, so now we'll talk about some workforce securities and investments and abandonment losses when it comes down to your investments. A key thing here is the timing of the worthlessness for the tax deduction on the worthless investment when it comes to tax purposes. Just because you have an investment that was written down or written off on your financials or for book purposes doesn't necessarily mean it's the right year to take that loss on the tax side. For tax purposes, you need to make sure that the investment is really completely 100% worthless and there's no reasonable expectation that you're going to get any future value out of this investment and by that it's not even a penny. No dollar is going to come to you out of this.

Specifically, you want to be sure to take the loss in the right year, but the earliest year that's possible because if it comes to be a later year, let's say you take your loss in 2024 and this was the year that you determined there was some sort of clinching event like bankruptcy or the investment sees its operations, but maybe in two, three years down the line the IRS can come back and contest that and if they say that there are certain facts leading up to this, that really the law should have been in an earlier year, you might be out of statute to go back and now amend your return to take and get a refund for that loss.

So you want to make sure it's the right year, but also the earlier of the year so that you can have that benefit. It's really on the taxpayer to really prove that it's worthless in the current year and like I said, there might be a clinching event in the current year, but you also might be some facts leading up to that. You want to be mindful of like to memo and to document why you feel that this is the current year such as projected cash flow, is there a plan of liquidation in place? What is that plan? If you're an equity holder, is there debt and are there more senior holders to you that if there is some sort of value or some assets are sold, they will come first and what is really going to come to you. And if you can show that that's really nothing, then these are more ways to show that this is really the right year to take the taxes.

Simcha David: It's really important that sometimes people think, well, the company went into bankruptcy or filed for bankruptcy and that's going to be the year, not necessarily. You may have to wait for the court to issue some sort of judgment stating where the value's going and that it's not going to you. So you just have to be very careful around that. Just going into bankruptcy is not necessarily enough to say that what you're holding is completely worthless, because you could be holding something that might not be completely worthless, so you have to be careful there and you don't want take, don't want to take the wrong tax year. You pick the wrong tax year and sometimes you can get whipsawed where they could disallow it in that tax year, but the tax year that you should have taken it is already closed and so there's a lot of different things that going on. Just be careful from that perspective.

Estee Kushner: Yeah, exactly. And then just moving on to abandonment losses. This is similarly when you have a partnership investment that you feel might be worthless, there's potential to take an abandonment loss on this and that one advantage of an abandonment loss is that you can get potentially ordinary treatment, which we'll get to in a second, but the partnership interest, in order to take that abandonment, you really have to show that your intent to abandon it and some sort of affirmative act of abandonment like there has to be observable, something concrete. Doesn't have to be that you're giving up legal title necessarily, but a letter to the company, some sort of notice or a memo explicitly saying that you are basically hereby giving up your ownership and anything that comes along with it, the determination for treating this abandonment loss as ordinary really depends if you have any liabilities that are be allocated to you at the time of abandonment, essentially the liabilities would be cashed considered as cash or a deemed sale if that would be allocated to you and that kind of nicks the ordinary treatment and turning into capital.

So best practice would be to, as you're thinking about abandoning a loss or some sort of worthless partnership investment towards year-end, also get rid of or alleviate yourselves from having those liabilities allocated to you at that time by that same notice to the company or some sort of memo to just say that you're washing yourself with these liabilities and then you can potentially get that ordinary treatment on that loss. It looks like we have a polling question now.

Bella Brickle: Poll #3

Simcha David: It's an interesting question, but sometimes you can. I think by the question we meant, is it automatic? And the answer is obviously not. For book purposes, you just write things down when you think they don't have much or not a lot of value or you're not sure about the value. For tax, they have to absolutely be pretty much completely worthless. I've had these conversations with clients all the time, they're like, "It's worthless. I want to take the loss." I said, "Okay, I'll buy it for a dollar." "No, no, no, no, no, no, no, I don't want to sell it." I said, "Okay, then it's not worth it." So just keep that in mind. Okay, let's move on.

Estee Kushner: Okay, just covering some structuring opportunities. Usually first and foremost on everyone's mind is section 1202 qualified small business stack. I can tell by everyone's reactions as well. We're just going to cover some key highlights here, the main requirements and some hot topic points, but we will be having a more in-depth discussion, a discussion webinar coming up, so look out for that. The first couple of requirements here really is on the stock, on the corporation itself. So it has to be issued by a domestic C corporation and it has to meet the gross asset test and the active business requirement test. The gross asset test is the tax basis of the issuers assets can't exceed the 50 million before and immediately after issuance and after business requirement is 80% of that issuers assets has to be used in an active trader business and this 80% is measured by value.

This test has to be met not just at the time before and immediately after, but throughout substantially all the taxpayer's holding period. This stock has to be acquired on original issuance, so no secondaries. And another important point here is that we get this question sometimes too if holding the stock through a partnership disqualifies it, and the answer is no, it doesn't. However, the partner does have to be a partner in the partnership at the time that the partnership acquires the stock in order for it to be eligible for exclusion, it has to be held by a non-corporate taxpayer and it should be held for more than five years as well. Now sometimes the stock would be qualified for QSBS for the exclusion, but it's not held, it's sold prior to being held for five years. So there's an opportunity to take the gain to sort of defer the exclusion and take the gain and roll it into a new QSB stock under section 1045, carry out the holding period under that stock and then take the exclusion on that sale.

Again, something that will be covered in greater detail. The gain that's eligible for exclusion is limited to the greater of 10 million. One point I also wanted to say is that it's really important for the taxpayer to be able to substantiate the eligibility. It's their responsibility and the burdens on them to be able to substantiate this. We see this coming up a lot with the IRS is questioning substantiability as substantiation on some audits, not necessarily QSB audits particularly, but it has been coming up. So just want to put that out there that it is favorable and we can get to good conclusions, but it's really on the taxpayer to be able to substantiate it. The gain that's eligible for exclusion is limited to the greater of $10 million, which is a lifetime limit or 10 times adjusted basis of the stock. The holding period does tack in certain scenarios.

If it's a transfer by gift or debt, certain tax-free exchanges as well as if the stock is distributed out to the partner. First of all, if a stock is distributed out to a partner, it doesn't taint the QSB status. The holding period does also tack. On the flip side, a stock is contributed to a partnership that will kill, in exchange for partnership interest that will kill the QSB status. So it works one way to distribute it out but not to contribute it back in. Options, warrants, convertible debt, this can all qualify for QSB once it's exercised and converted. What's been coming up recently as well is the question of safe agreements, if and how this can qualify, and this is a much more nuanced, it's more of an involved analysis and it will be discussed further, not necessarily does or doesn't qualify, but it's much more involved and on our webinar.

So stay tuned for that. We'll go into it in much more detail on how to get there as in addition to carried interest, that can also potentially qualify for QSB status and always consider state conformity because just because you're getting the exclusion on the federal side and getting that tax rate, not all states conform, so you might be hit with the tax law on the state side. So just to be mindful of that when you're going through your tax planning. And we have another polling question.

Bella Brickle: Poll #4

Simcha David: Waiting, we talk about carried interest may qualify. The reason carried interest becomes possibly a little bit of an issue is because you do need to be a partner in the partnership from day one. Now, if you are a GP that does not have a capital interest, all you have is profits interest, does that make you a partner from day one or does that just bring into existence as a private equity fund? When you sell an investment, that's when the profits interest. That's when it's considered to come to you. So that's a nuanced question that gets asked. There's also some language in section 1045 people are worried about, but that's not a 1202, technically that's that language. It's your lowest interest that you held, which would not be great in the carried interest realm. That is a 1045 terminology, not a 1202 terminology. So many of you may have had this conversation in the past, but be aware it's a little bit of a... It's why it says may qualify, because the carried interest springs into being at some point. Okay.

Estee Kushner: Okay, looks like we got majority here. Okay, moving on. We're just going to touch on blockers for a little bit. We're running out of time and I want to make sure we get to the rest of the slides so we have some good content here. But just two, three points on having a blocker in place in your structure. It's really generally there to protect our tax-exempt investors and our non-US investors from the trader business activity that comes through from a flow through partnership going up to a US operating partnership flowing up to the fund to protect them from the UBTI and ECI activity that comes through, which would be at higher ECI rates, capital gains rates.

So instead the domestic blocker will pick up that activity and generally have a lower tax liability on that activity. Just one thing to be mindful of is when the blocker does make a distribution out to the partnership, to the extent that there are positive E&P, earnings or profits at the blocker, that distribution can be a taxable dividend to the investors and the non-US investors can be subject to 30% withholding. If that is a liquidating distribution, then it's generally not taxable. So sometimes you would want to keep the cash until there's a plan of liquidation in place and then distribute the cash under that, alleviating the withholding tax and the character of the taxable dividend,

Simcha David: Which is why you're going to get to your next slide, which is why sometimes people do leverage blockers. It's a way to get cash back without having to pay an equity distribution, which might be a dividend or sometimes in structuring, people will use this particular blocker for particular investment so that you know that when you sell the investment you can put the plan of liquidation in place so you get the money out. But if that doesn't work in your particular structure and you hold multiple investments underneath, the leverage blocker does work. But go ahead.

Estee Kushner: Yeah, no, that's exactly right. And there's just one more point on the leverage part of it just to consider the interest rates, the fluctuating interest rates to keep re-evaluating or revisiting what that should be, the rate on the leverage. In addition, the interest expense side, just be mindful if there's any, it might have limitations under 163(j) or even 267 since there are things to plan for ahead of time to know what you would be eligible for. Just very quickly on 1446(f) again, there's a lot on this slide, but just to keep in mind, it's about if there's a foreign person who's selling its interest in a partnership, the transferee would be subject to tax on 10% of the realized amount.

Now, there are a lot of exclusions here. We're outside the scope of this and want to get through it, but we just wanted to bring this up. In addition, if the transferor fails to do this, the burden can actually fall to the partnership to withhold the liability. Okay. I think we're going to continue with distributions. Irina, you want to pick up here or go to updates in the interest of time?

Irina Kimelfeld: Yeah, just really quickly on the, it's not really necessarily structuring consideration, but the IRS is very keen on keeping track of people's partnership spaces. This is one of the areas that they're looking at and there are significant basis considerations when you have distributions in kind. So if we're distributing securities. If we're distributing, we're distributing interest in portfolio companies, what does that do to the basis of the partners and whether there is gains to be recognized, because there are different rules for whether it's a current distribution, which means it's just distributed in a normal course of business of the partnership or if it's a liquidating distribution.

Distribution of securities is generally treated as money except for investment partnerships, which is what most of our funds are. So keeping track of both the basis of the fund in the hands of the partners as well as the basis of the distributed security. And that's the information that needs to be provided to the investors as well as reminding them that the investors really should keep track of their basis in the partnership. There is now a proposed new form out there that will be highlighting and providing additional information to the IRS with respect to property distributions. Once again, highlighting IRS's interest in making sure that the basis is being kept properly both at the partnership level and then at the property level that is being distributed.

Simcha David: Very interesting, Irina. That's something we came across. If you have, let's say a private equity fund that does earn flow through business investment income from some underlying investments, so then technically it might not be considered an investment partnership anymore. So take one of those partnerships and then they have a portfolio company that goes public, let's say, and they're still holding the stock and they want to distribute that stock. Well, now what happens, it's a publicly traded security when they distribute it, but they held it for a while as a non-publicly traded security and they're not an investment partnership, because they do have flow through business income. There are other ways perhaps to get around that from other areas of the code, but you could see how that might be an issue, because technically, publicly trade security should be money versus, and that would trigger gain on distribution versus what you're used to seeing in investment partnerships is that the security doesn't trigger gain. It's up to the investor when to realize that gain and sell the security. So I'm just pointing that out.

Irina Kimelfeld: And to some degree we do see more security distributions for various reasons. One of the reasons is kind going back to the 1061 considerations, distributing security in kind and letting the GP age that into the three years as opposed to having having it being sold. So I've definitely seen some GPs taking their carrying security effectively. We do have maybe two minutes. Very quickly, legislative updates.

Simcha David: This is a segue into part two, because this is kind of where.

Irina Kimelfeld: We will have a much more robust legislative update, but some things to sort of look forward to. Obviously we've just gone through the election. Everything that we know on the proposed tax plan is codifying the or making permanent changes that came in with TCGA. So that's some of the rate deductions. That's a pass through deduction from partnerships if they're traded business partnerships.

Except the SALT deduction. So the indications are that the SALT deduction may come back even if the other 2017 Act provisions become permanent. But there's sort of still debate out there. There's a proposed reduction on the corporate rates both from 21 to 20, but also potentially to effective rate of 15% for domestic production. So that might be coming back. We talked about the Soroban case. Just a reminder on why a global case, it's not a legislative update, but rather it was decided in the courts and it's really in the realm of credit funds and potential originations.

So if there is a credit fund out there and there are questions, whether they're buying debt on the secondary market or originating can have very negative implications for any non-US investors in that origination income is ECI. So if there are concerns around whether the fund is really an investor fund or originator fund, even if the fund continues to take its position as an investor and not an originator, there's probably some protective filings that have been highlighted in why a global case that were folding filings and potentially foreign corporate filings that should be done on a protected basis or thought about.

FinCen Beneficial Ownership Information Reporting, it's not really tax but it is in treasury, so we get questions about it. A lot of entities, I'm not going to say all because there are exceptions, but a lot of entities, newly formed entities and the entities that have been previously in existence have to provide information about their beneficial owners who owns them. New entities have to report within 30 days. The old entities that were in place last year now have until the end of this year to do the reporting. We usually refer folks back to their council and have some firms that we work with to help them with these filings. But if nobody has mentioned this to you before, something to look into. We are definitely seeing an increase in IRS partnership audits as well as if you are lucky enough to have management companies in New York City, we're seeing a whole bunch of those.

The IRS is focusing on self-employment tax issues. As we've highlighted before, they are also focusing on the why a global case was addressing to the extent there should have been effectively connected income that was not reported or under-reported. There is a focus on that and just some of other issues. And as you've seen last year, the partnership tax return form 1065 and K-1s and the required disclosures have been greatly expanded. So IRS is definitely seeking more information on the activities of the partnerships, on the basis, on 475(f) gains and losses. And like I said, they're also asking more questions about property distributions now

Simcha David: And just to what we spoke about the SALTs very quickly, the SALT deduction coming back. There are certain states, we'll get more on that on the state and local tax update on our third part of the series that are automatically getting rid of their PTET regimes when the state and local tax deduction comes back. Other states might keep them both working concurrently. There's probably a little more benefit in the state PTET than there was in the SALT deduction. So just something to keep in mind if ultimately they do allow the SALT deduction limitation to sunset and allow the SALT deduction to come back. Thank you both, Irina and Estee. This was fantastic. Thank you for your presentation. I'm going to hand it back over to Bella to finish the presentation.

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