Frequently Asked Questions - Fund Taxes

2 min read

Sep 27, 2022 9:53:04 AM | Assure

Our full suite of services help CFOs, CPAs, attorneys, and private equity organizers to navigate basic or complicated financial and regulatory requirements. We act as trusted fund tax advisors, putting our experience to work with best practices for tackling compliance and regulatory issues. Here we have compiled the most frequently asked questions about fund taxes, along with our experts' answers from their expertise in preparing taxes for over 5,000 funds:

When will I receive my K-1?

You will receive your K-1 as soon as the fund's tax return has been completed. If the tax return has not yet been filed, Assure may be pending a K1 from the portfolio company or information from your organizer.

How will I receive my K-1?

You will receive your K-1 either through Glassboard or a Box Folder. As soon as your K-1 is ready, you will receive an email notification as to how to retrieve it.

I'm foreign, do I need to file a return?

Advisor-01As an investor in the fund, we are required to send you a K-1 from the fund and also send the information to the IRS. Whether or not you need to file a US tax return depends on many factors. Since Assure is not a tax advisor, we suggest that you contact a CPA or tax attorney who can give you personalized guidance.

Why does my K-1 show income/I never received this income?

OID INTEREST Under current tax regulations, convertible notes (held by Fund A) are considered to be a type of OID (Original Issue Discount) instrument. Internal Revenue Code section 1272 requires holders of OID instruments to recognize interest income every year despite no interest being actually paid out. This requirement remains in effect whether the note holder uses the cash or the accrual method of accounting.
CONVERSION During the year, the convertible note held by Fund A converted into preferred shares. At the time of conversion, rather than paying cash for the interest accrued, the company issued additional shares to the fund. Because the fund recognized this increase in value, the tax code considers this taxable income and requires that it be passed through to the fund's investors.
LLC PASSTHROUGH Fund A invested into Company B which is a partnership/LLC. Under the tax code, partnerships/LLCs do not pay their own tax. The income or loss of the partnership/LLC is passed through to partners/members who recognize their portion of that income/loss on their own returns. Although Company B had a profit for the year, they have not made any distributions, but have instead reinvested that profit back into the company. Despite not receiving any cash, investors are still required to include that income in their individual tax returns.

I heard that the underlying investment went out of business or is on its way out. Why is there no loss on my K-1?

Assure cannot shut down an SPV before a bankruptcy or other official proceeding has run its full course.

I invested in Fund A, why did I not receive a K-1?

Fund A neither received income nor incurred any expense during the year and therefore had no tax filing requirement. As such, no K-1s were issued for this fund.

How do I fill out the Form W8/9?

Advisor-01As Assure cannot provide you with tax advice, we are not in a position to aid you in filling out the form. We have attached the instructions to Form W8, but if you require any additional guidance, we suggest that you contact a CPA or tax attorney who is familiar with your situation and can provide you with individualized advice.

The company had a down round during the year. Why doesn't the loss show up on my K-1?

The assets held by the funds are accounted for at their cost basis. As these funds are only passive investors, we do not mark to market. Only active dealers and traders in securities may elect the mark-to-market accounting method.

Why am I just getting this K-1? Aren't K-1s required to be sent by the end of January?

The due date for furnishing K-1s to investors is the same as the due date for filing the Fund's tax return. The initial deadline for the prior tax year is March 15. However, if additional time is required to file an accurate return, an extension of time to file may be granted. Once an extension has been filed, the deadline becomes September 15.

There is a distribution amount on my K-1, but I never received the cash. What happened?

Finalize Investment-01Distributions are credited to your account. The Organizer will decide if distributions are sent to the investors in the fund.

Fund A holds a note from a foreign startup. Do we need to know if the company is a CFC and/or a PFIC?

No. This only becomes an issue when the fund holds an equity interest.

Fund A had an exit, but some of the proceeds are being held in escrow. Will we recognize all of the gain this year?

No. The gain will be recognized when the funds held in escrow are released.

Can we allocate different assets to specific investors?

Distributions-01Yes. Creating different asset classes with your fund creates additional administration and tax work obligations. Assure's standard service does not include asset classes; however, Assure can accommodate the service. Please reach out to Assure to discuss adding this service.

How does a sales charge that comes out before money goes into a fund affect the investor's basis?

We only track the fund's basis in its assets. There are several factors that can affect an investor's outside basis. As such we do not track investor basis. Please consult your tax advisor for additional information.

What is Effectively Connected Income and do our funds have it?

ECTI comes from the operation of an active trade or business. Since the SPVs are just passive investment vehicles, effectively connected income is almost never an issue.

Investor-01 Do investors investing through exempt entities (i.e. charities, endowments, IRAs) need to worry about Unrelated Business Taxable Income?

The majority of investments do not rise the level of being a trade or business and therefore would not have UBTI. Typically, the only income produced by these funds is interest from convertible promissory notes or capital gains from the sale of stock. These types of investment income are not considered UBTI. Occasionally, there are funds that produce ordinary business income which may subject the investor to UBTI. IRS Publication 598 may be provided as a reference, but they should consult their tax advisor for additional guidance.


US Investors (Backup Withholding) The internal revenue code and regulations are not clear as to whether or not partnerships are required to withhold tax on behalf of any US investors who are subject to backup withholding so we spoke with the IRS regarding the matter. We were told that we should NOT be withholding unless an investor provides us with a letter from the IRS stating that the investor is subject to backup withholding or the IRS notifies us that we need to withhold. Simply marking on the W-9 that the investor in subject to backup withholding does not mean that we need to withhold. We must have the letter. The IRS rep stated that if we were to withhold without that letter, then we would be violating IRC 3402(p)(3) which basically says that you cannot voluntarily withhold. It has to be mandated by the IRS. We are also not required to ask for the letter. It needs to be volunteered by the investor or sent by the IRS. We will not be doing any backup withholding for US investors unless we receive a letter.