Financial Services Year-End Tax Planning Webinar Series – Part 1

As the year 2022 with all its turbulence begins to wind down, the recent webinar “Financial Services Year-End Tax Planning – Part I” engaged its listeners in a discussion surrounding year-end planning for funds, general partners (“GPs”) and management companies. The discussion was led by:

• Daniel Krauss, Partner, EisnerAmper;
• Lindsey Layman, Partner, EisnerAmper; and
• Paul Kangail, Director, EisnerAmper.

The panelists discussed topics hedge fund managers should consider as they work to harvest losses as the year comes to an end, including:

• Wash sales - when a security is sold at a loss and then a substantially identical security is purchased within 30 days before or after the sale (61-day window), the loss will be deferred for U.S. tax purposes. There are a number of ways with proper planning the losses can still be harvested:
  • Replacing the loss security with something similar but not identical;
  • Doubling down: purchase an identical number of shares and then only sell the first block after 31 days; and
  • Selling securities that were subject to wash sales in prior years to free up losses.
• Straddles - when one holds offsetting positions in actively traded personal property. When one leg of the straddle is sold at a loss, the loss is deferred to the extent the other leg has unrealized gain. The use of an identified straddle can control the size of the straddle.
• Constructive sales – gain is taxable when an unrealized appreciated position is offset by another position if the position reduced both gain and loss potential. If the conditions of the closed transaction exception are met, then unrealized gain won’t be taxable.
• Short sales – covering shorts at a loss. Short sales have to settle before year-end to be allowed in 2022.
• Worthless security – per 165(g), a loss is treated as if it were a hypothetical sale of security on last day of the tax year, when the security has no current or future value. The taxpayer is responsible to make this determination.
• Is the fund a trader or investor fund in 2022? This is an annual test, so if something changed significantly from the prior year, the status of the fund may have changed. In a trader fund, expenses can be used to offset ordinary income, but in an investor fund post Tax Cut and Jobs Act (“TCJA”), the expenses are non-deductible.

The discussion continued with items relevant to all fund managers, GPs and management companies, including:

• Schedules K-2 and K-3 – these forms were introduced in 2021 to replace the former line 16 on Schedule K-1. These forms significantly delayed the process of the return preparation from both the partnership and partner’s perspective. The 2022 draft instructions provide a very narrow filing exception, which also requires partnerships to issue partner letters by January 15 (two months before the original due date of the partnership tax return), letting partners know they will not be receiving K-3s. As such, K-2s and K-3s may be filed for more partnerships.
• State and Local Taxes (“SALT”) – the panel briefly touched on state and local tax issues, including but not limited to the pass-through entity tax (“PTET”).
• Qualified Small Business Stock (“QSBS”) – provides a gain exclusion of either $10 million or 10x the basis of the stock. Fund managers should ensure that when QSBS sales and distributions occur, all service providers are aware and the transactions are properly disclosed to the investors.
• Section 1061 – The three-year holding period to receive long-term capital gains rates for carried interest remains in effect.
• A Qualified Opportunity Zone (“QOZ”) fund is an investment vehicle that enables taxpayers to defer all or a portion of their eligible gains for federal income tax purposes. This election is available to taxpayers that invest their eligible gains into a QOZ fund within a 180-day period beginning on the date of the sale. If the eligible gain is from a pass-through entity, the 180-day period may begin on the original due date of the pass-through entity’s tax return without regard to extensions. These deferred gains will be included in the taxpayer’s gross income by the earlier of December 31, 2026, or the disposition of the taxpayer’s investment in the QOZ fund. It is important to note that if the QOZ investment is held for ten years, 100% of the investment appreciation will not be subject to federal income tax.
• IRC Sec. 461(l): Excess Business Loss Limitation – this limits the amount of trade/business losses non-corporate taxpayers can use to offset non-business income for tax years 2021 through 2028. The 2022 excess business loss limit is $270,000 for unmarried taxpayers ($540,000 for joint returns) and is applied after other loss limitations, including outside basis, at-risk and passive activity loss limits, are considered.
• Bonus depreciation – new or used depreciable property with a useful life of 20 years or fewer, such as furniture, computers and vehicles may be eligible for this tax benefit. For the 2022 tax year, 100% of the purchase price of qualified assets placed into service is deductible. After 2022, the first-year bonus depreciation limit will phase out by 20% per year until the deduction is no longer available after 2026. Taxpayers have until December 31, 2022 to make qualifying purchases that will enable them to take advantage of the first year 100% depreciation limit.

The webinar can be viewed here.