Part I | Tax Planning for Funds, General Partners and Management Companies

So with that, let's get started with our hedge fund tax considerations.

Okay. So why plan before year end? Why are we here on this webinar? Why are we talking to you about this? Well, really the time is between now and December 31st is really your last opportunity to be able to change the outcome for your 2026 tax picture. After December 31st, really we can only report on what's happened. There's not too much we can do to actually change the outcome. So now is a really good time for funds to go through, look at their year to date activity and really kind of understand where they are from a tax perspective. And how do a lot of funds do this? Well, we have a number of clients and a lot of funds that will go through some type of tax estimate process prior to year end. We'll take a look at data through either September, which would be available now, or we will look at data through October, which will be generally available in a couple of weeks.

And we'll start to try and get an understanding of where the fund stands and try and minimize any surprises that would happen between now and then when you're eventually doing your K-1s up in March. So we'll look at what you've realized throughout the year, what are you still holding at the end of the year? What's your economic income, your book income versus maybe your tax income that could be significantly different? And ultimately, how are those tax items be allocated to your LPs and to your GPs? Nobody likes surprises, so we're trying to get ahead of that. We want to understand tax character and try to go through some type of tax mitigation techniques, loss harvesting, be aware of certain book to tax differences that we're going to go through in a few slides. We want to, again, set expectations kind of early with your LPs and also with the GPs, what can they expect come K-1 time in March?

We're able to identify issues and try and create some tax efficiencies now much better than if we're trying to deal with that in March. You want to give an expectation to K-1 timing, maybe there's carried interest issues, maybe there's withholding that you weren't sure about. These are all things that we can use kind of a tax estimate prior to year end to get ahead of. And then ultimately trying to understand and have a plan for some of your end of year cash flow planning. If you had a big year, there's a lot of taxable income, there's going to be a tax bill due with that, some quarterly payments, then obviously your year end payments come next spring. So having a plan to manage your cash flow is something that we can do now as we're understanding what the tax picture is for 2026.

Mark Stahl: Brett, if I may just elaborate one of your points also from the GP perspective, they should also think about now as they're going into fourth quarter, their PTAT payments, what GP might have to pay if they're electing into PTAT. So that's another thing they should also keep in mind that they might have to make a payment, whether it's estimate or especially before extension time.

Brett Cornell: Absolutely. Thank you, Mark. Okay. So on an annual basis, one thing you want to be looking at is whether your hedge fund is going to be treated for tax purposes as a trader fund or investor fund. An investor fund, these are your funds that are looking for a long-term appreciation in the market. It's more kind of a buy and hold type of strategy. Conversely, a trader fund, these are funds that are looking to take advantage of short term swings in the market, more akin to your day traders. So why does it matter for tax? And really the main thing to note here is deductibility of expenses. So the fund's going to have expenses, right? You're going to have professional fees, maybe you're paying Eisner, maybe you're paying your fund admin, you're paying your law firm, et cetera. There could be research fees, your Bloomberg terminals, things of that nature.

All these are real fund expenses that they're actual cash outlay for the fund. But if you're an investor fund, those expenses are viewed as what we call portfolio deductions under section 212 and under current law, those deductions are effectively non-deductible for individual LPs. Trader funds on the other hand, are viewed by the IRS as being a trader in securities and the business of being a trader in securities and therefore those same expenses are good business deductions and your individual LPs will be able to benefit from those same expenses. So there's a real after tax rate of return consideration when you're thinking about trader versus investor funds. Now, so why wouldn't everybody want to be a trader fund? And we get that. We speak to many clients on this. Ultimately it is more advantageous from the expense deductibility perspective. However, you have to have a position for it.

And while the IRS doesn't have a bright line test, you're not going to look in the code and see, hey, if you hit all these five items, you're automatically a trader fund.You're not going to see that, but in industry, there are certain things that we will look at to help substantiate that position of being a trader in securities. One of those is volume of trading so that you're trading a lot throughout the year, continuous trading, you're trading basically every day throughout the year, just not spotty throughout the year. We're looking at holding period. Are you really holding securities for just a couple of days or is it more long-term holding periods? Your character income, short-term capital gains versus long-term capital gains, portfolio turnover. We want to see the portfolio turnover a number of times. And then ultimately, what do your fund documents say? If your fund documents, if you take a position as a trader in securities, but then you look at your fund docs and they say, "Oh, well, the intent of my fund is to generate long-term capital gains in the market we're buy and hold." Well, that might not hold up under an IRS examination.

So certainly this is an area that you want to review on an annual basis. It's an annual test and a position that is taken on the tax returns. So something to speak with your advisors about.

If you are deemed to be a trader in securities, you do have available to you a 475F election. That's the mark to market election that you may be familiar with, essentially just converting all of your realized gains on your securities to ordinary income as opposed to capital. And then there's also a mark to market at year end as well. So if you're a 475F fund, it generally does kind of simplify your compliance process. You might be able to get some more beneficial treatment on if you happen to be in a loss year, but again, something that needs to be evaluated to your advisors as there are deadlines.

Mark Stahl: Brett, if I may just elaborate here at this point, I think the major difference to highlight between a trader fund and a 475 mark to market fund is, if you think about it, a trader in a sense is really looking for short-term swings in the marketplace. So most of the capital gains, as Brett mentioned, is going to be short-term capital gain versus long-term capital gains. So you're ready in the highest ordinary rate. Now, the ordinary piece is also at the highest ordinary rate, but what's really the benefit, let's say over a trader fund versus a 475 fund? A trader fund still allows you to have that deferral ability. There's no mark to market concept. It's only you're only being taxed on your realized capital gains versus the 475 fund, right? You're being taxed as mark to market as if you sold all your positions at year end, and that takes away your deferral purpose.

Where does a 475 really come into play and it's helpful for a quant fund or somebody who's just trading literally every day and they're more like day traders. So at the end of the day, they're in and out of positions constantly and their benefit is they don't want to deal with the wash sales that Brett will talk shortly about straddles, constructive sales, all these what we call tax M1s. That could be hurtful at the end of the year if you have a lot of losses and you're constantly going in and out of positions where things could come back and say, "Hey, we can't deduct it at this point." That's where a 475 fund is a little bit more beneficial because everything is deemed sold and that's where the benefit of a 475 comes in. But if there is a fund that's looking more for income deferrals, a 475 might not be the best election for you.

Brett Cornell: Great. Thank you, Mark. The last point here just on carried interest, we'll go through that a little bit later. Section 1061 is a three year holding period rule. That'll be generally more applicable to your investor funds than your trader funds because that's concerned more with your long-term capital gain treatment. Okay. So as Mark mentioned, there's several items, book to tax adjustments or security analysis that we go through on an annual basis. And really there's kind of the big three to look out for. Those are your wash sales, your straddles and your constructive sales. Just briefly on each, a wash sale, that's where you sell a security for a loss. And if you happen to buy a substantially identical security either 30 days before or 30 days after that loss realization, the loss will actually be disallowed for tax purposes. So economically on your books, you might see that you have a capital loss, but because of the wash sale rules, there's actually going to be a timing issue there.

The IRS won't let you take that loss. The theory is that, hey, you're economically still in the same place, right? You purchased back into substantially identical security, whether it's the same security or maybe an option for the same security, and therefore they don't want you to kind of accelerate losses early. So that's where the wash sale rules come into play. Straddles, that's when you have offsetting positions in actively traded personal property, such as maybe your longest security and then you put a put option on where you're going to have substantial diminution of the risk of loss. So there, the losses are also going to be disallowed and the losses are disallowed to the extent on the one side, to the extent of your unrealized gain on the other side of the transaction. So again, the IRS doesn't want you to kind of accelerate losses in one year while deferring gain on the other side of the transaction in a subsequent year.

These are timing issues, right? The losses don't necessarily go away, but it is a timing issue whether you're going to get the benefit this year or maybe a future year. Constructive sales, that's when you have offsetting positions of appreciated financial positions. So if you have an appreciated position in a security and then you decide to short it or you decide to short it, for example, and you box in that gain, that's considered a constructive sale and it's as if you kind of boxed in what that gain will be. You don't really have a risk of loss there. The IRS, again, economically, they feel that you don't have the risk of loss, so they're going to actually accelerate the gain pickup when you have a constructive sale. There's some rules around, it's much more complicated than kind of what we've just laid out. There's going to be some rules around holding period and basis and et cetera, but ultimately what you're going to want to do prior to year end is be able to identify these types of transactions.

We have software that we use to work through that and really identify these types of transactions early because there are some techniques that we can employ to be able to get the preferential tax treatment. If we knew it happened during the year, we can maybe try and unwind some of it before year end.

Mark Stahl: I think one of the main things just from a constructive sale purpose that everybody should be made aware of is if you have a long-term holding period and you decide to box that position, then obviously the holding period still stays. If you have a short-term holding period and you go into and you hedge that position and also keep in mind constructive sales as of 2004 also became straddles for that matter. So holding period is terminated. So if you held something, for example, for 300 days on the short side and you have a short term holding period and then you decide to box it, you lost 300 days of holding period. And if you unwind the box, the holding period starts again at day one. It doesn't get suspended, it's terminated and it starts again at day one. So keep that in mind before you want to box a position or have a constructive sale.

The government deems it as if it was sold on the date that you boxed it. So for long-term ones, if you achieve long-term, not a problem, but if you have short-term positions, it will terminate your holding period. Keep that in mind.

Brett Cornell: So other adjustments and reclasses to make you aware of section 1256 contracts. So to the extent that you are trading futures or trading index options, these generally qualify as 1256 contracts to get the preferential 60% long-term, 40% short-term capital gains rates. 1256 contracts are also marked to market at year end. So to the extent you're holding any of these types of positions at year end, it's deemed as if you sold it. So you will have to be picking up either the gain or the loss, whatever the spread is at year end. And again, a timing difference, but something you need to be aware of. Same goes for FX forwards. If you're trading any types of FX forward contracts, particularly on those that are considered a major security, those are marked to market at year end, ordinary in nature, section 988 type of income. You're going to also want to look out for, if you're trading swaps, kind of being able to understand whether you're trading total return swaps where there's periodic payments throughout, or perhaps they're bullet swaps where there's one lump sum payment at settlement.

There's going to be different tax treatment for each. And generally speaking, the total return swaps will also be marked to market. So again, something that if you're just looking through your books and you're looking at your economics, it might not tell the full story if you're trading these types of products. Market discount - Go ahead, Mark.

Mark Stahl: Sorry Brett. I think for the last three that Brett mentioned, be aware of phantom income that tends to sneak up on people and it tends to be a surprise later on and they go, what do you mean? It's unrealized and I still have it in my portfolio. And then they generate a lot of taxable phantom income that accelerates the tax liability for their investors and it's a little bit of a surprise. So be aware of these types of things. I would just say on the last point of total return swaps versus bullet swaps, it's very important where Brett was talking about before, whether you're a trader fund versus an investor fund. If you're an investor fund, it's very important. If you're going to trade on swap, you probably want to do everything on bullet swap. The reason that is because it's considered at least when you terminate its bullet, it's going to be a capital gain when it terminates versus a mark to market concept.

And total return swaps are mark to market. And if you have losses on your total return swaps, you're going to end up having, you're not going to be able to take the losses. The losses are considered portfolio deductions and they fall under section 212 and you won't be able to take it if you're an investor fund. So trader funds we usually typically find do total return swaps more often and bullet swaps are usually found more in the investor funds because it preserves at least the losses from that standpoint.

Brett Cornell: Great. Thank you, Mark. Just quickly, two other ones. Market discount. We see that's another one that surprises a lot of people. We see that a lot with our credit funds. Basically if you buy debt on a secondary market at a discount, when you eventually go to sell those positions, the difference between your cost versus the par value that's going to be prorated by your holding period will actually get reclass from a capital gain to interest income. So that's something that a lot of folks are not necessarily aware of. They're thinking they're getting nice maybe long-term capital gain treatment on some of their debt instruments that they're selling, but ultimately some of them might be getting reclassed to ordinary interest income. So certainly something you want to understand. There is an exemption for certain distress debt, but something that you're going to want to discuss with your tax advisors and make sure you really got an understanding of what the outcome could be there.

And then quickly, worthless securities. A lot of folks are writing down instruments on their books. They feel that they're worthless. It's not necessarily so easy to get a capital loss on the tax side for those same securities. Really incumbent on the fund to make sure they have great documentation and correspondence with the company. For example, if there was some type of triggering event that made it worthless. So for example, liquidation, insolvency, maybe a bankruptcy. And ultimately we tend to advise clients that if it's really worthless, it might make sense to just sell for a nominal amount so you can get that loss in the current year. Okay. We are at our first, or sorry, second polling question. You currently provide year end tax estimates to your LPs. True, false, not applicable. About 60 seconds to answer that.

Mark Stahl: So Brett, I'll go into the Q&A while we're waiting for the 60 seconds and do a couple of questions. One question was, does 1061 three year holding period apply to trader funds? And the answer is the 1061 code section for GPs, that means they have to hold everything for three years in order to get long-term capital gains, applies to trader funds and investor funds. So in order to get long-term capital gain, if you're a GP receiving a carry, means it applies to the carry portion, not the capital portion, you have to hold it for at least three years. It doesn't matter if you're a trader fund or you're an investor fund. Another question came in regarding a pattern on K-1 reporting where trader funds often aggregate various line items into line 11, while investor funds report it typically on all the lines of the K-1.

I think that is a style of a particular firm of how they want to approach it. We see clients report trader funds and investor funds similarly and they use all the lines and we'll go from there.

Brett Cornell: Great. Thanks

Mark Stahl: For

Brett Cornell: Actually

Mark Stahl: Moving up to the firm that you're using.

Brett Cornell: We'll actually move on to 1061 as our next slide, but just quickly, we have about 52.1% of respondents do provide year end tax estimates to the LPs. So that's great. And then a bunch that do not, and another cohort where it's not applicable for them. Okay. So that was a timely question on section 1061 and our carried interest. So this is the three year holding period rule for carried interest that people have been very focused on as it's come into play over the last recent years. Basically what this is, is that if you are a GP or even a special limited partner, somebody who's receiving carried interest from the fund, any long-term capital gains or any gains that are associated with that carried interest, you're going to need to be held for a holding period of over three years to get the preferential long-term capital gain rates.

So for the limited partners, the long-term capital gain preferential rates, it's still the one year holding period over 365 days, but for the carried interest holders specifically, it has to be over three years. And there's a little bit of confusion in this particular area of what am I looking at in terms of holding period? Is it when I earn the incentive or is it looking at the actual individual assets? And generally it's looking at the individual assets, looking at the individual securities and the holding period of those. So if you're coming into year end here and you want to take a look at securities that are kind of straddling near that three year mark, if you're able to hold it for a little while longer to get over the three years, that's going to help the GPs from a tax efficiency standpoint. Obviously, if you have to sell a little earlier for whatever reason, your LPs are still going to get the benefit, but really it's the three year holding period that you want to be concerned with to make it as tax efficient as possible.

There are, as Mark mentioned, a differentiator between your carried interest, which is subject to the recharacterization rules here and your capital interest. So if you're a GP who puts your own money into the fund and you earn money and you generate long-term capital gains on that money, that's generally exempt from the 1061 reporting. It's a capital interest, but anything that you've actually earned carry on, that's where you're going to run into the rules here. And again, it's not just your realized positions. So you might have your carried interest is going to be made up of some realized gains and also some unrealized gains. The realized piece has got to be over three years. The unrealized piece, now that's going to carry forward into future years. And when you do eventually sell those securities, those same securities do need to be held for over three years.

But kind of the planning opportunity here is you want to make sure that you're actually bifurcating and tracking your GP interest between your capital interest and your carried interest. If you're just kind of tracking it all together, you may be kind of overstating your liability as it relates to section 1061.

The one other thing I'll add is that the IRS is getting kind of smart to this issue. They have installed a worksheet A that comes with the schedule K-1s where they require you to break out what's capital and what's carry. Then ultimately on the individual 1040s, there's a worksheet B where they kind of plot the numbers from the fund onto your individual returns. So not a lot of room to hide here and you really want to make sure that you're tracking things appropriately.

Mark Stahl: I think one of the main things here on the 1061s tracking is mandatory. You have to track it. And I think if you don't track it, the IRS will deem everything to be carried because you're commingling your funds. So I think it is very important for that matter to break it out and you could talk to your administrators how to break everything out properly and to track that. Also, keep in mind, especially for crystallized carry, there's going to be a point where you can say it's unrealized, right? Until it's totally filled up, it's still subject to carry rules, even if let's say you didn't pick it up at that point in time. So you could have, let's say $100 of crystallized carry and you have zero realization for the year. It's still subject to a three year rule in the second year. It doesn't just disappear because it wasn't picked up in the first year.

So you are tracking, let's call it your disparity account until it totally gets filled up. Just keep that in mind as well.

Brett Cornell: Okay. That we have our third polling question. For a GP's carried interest to qualify for long-term capital gain treatment under section 1061, what holding period applies to the underlying assets? One year, three years, five years. I'll give you 60 seconds there, but hopefully this will be a quick, easy answer for everybody.

Mark Stahl: So typically I would say Brett, when we do the 1061 worksheet A, which is now kind of a requirement, usually you see it only on the GP or anybody that we know is receiving a carried interest. Typically, the other investors will get a footnote because there might be a fund of funds inside your fund or there might be another fund that's invested in your fund that's taking carry on their level. So they do have to know for their perspective what their one to three year limit is in case they're going to take carry from that matter. But only the GP for the most part, the person that we actually know is getting carry on your level will get a worksheet A, and then everybody on their level will have to take that information and provide their own worksheet day. Worksheetday obviously then will go to the 40 where it goes on worksheet B, and they tally all their aggregated carry and they put it together and they make a determination whether on that level they have to reclass any long-term capital gains to short-term capital gains.

Brett Cornell: Correct. And one issue we do see a lot sometimes with special limited partners, we've seen that missed in the past where maybe they're not bifurcating their capital versus their carried interest and maybe they've moved it into a different account throughout the year or throughout the years, et cetera. Really important to just continue to track that disparity account moving forward for SLPs as well and make sure that those worksheet days are coming along with those K-1s. Okay, that's great. 79.5% got that right, three years. Okay. And then now that we have our full tax picture, once we've figured out where we're at from a tax perspective, we understand where some of the taxable allocations are going to from their GPs and their LPs. It's a great time to start to try to manage your cash flow and manage redemptions and distributions. So generally speaking, when we're working with clients on their tax estimates, we like to get an understanding of what the tax capital might be for the partners.

And the reason being is that in a partnership context, distributions are generally tax free to the extent of basis. So we can do some planning there to say, "Hey, here's an amount. If you needed tax capital of $5 million and you needed to take out maybe two or three million for your personal tax liability that's going to come due or your PTAP liability that's going to come due." We might say, "Hey, you have $5 million of tax capital, you could probably draw it from your account tax free." If not, you start to run into basis issues, maybe you're going to want to try and pull it from somewhere else. But this is an area where people don't want to have surprises when it comes to tax payments and how much they need to make and when they need to make it. Mark had alluded to earlier that we're seeing this a lot when you have folks that have their interest in entities where they're taking advantage of P-tech.

It's kind of pushed up the timing a little bit. New York and New York City have Q4 P-tech payments due December 15th. So really want to understand what that number might be. Again, also want to really understand what your individual tax payment might be. Alyssa's going to go into a lot of the individual stuff later on, but they have Q4 payments that are going to be due January 15th of 27. And then obviously you have to be fully paid in 315 for partnerships that might be doing some P-tech or 415 for individuals. So really important, particularly a lot of funds we've seen as it relates to redemption, they may need to be days in advance, et cetera. So if they're looking to try and cover their tax liabilities come the spring, now's the time to really understand what liability they need to plan for and where they can grab the cash from.

Okay. And then we just wanted to touch briefly also just on some of the offshore issues that come up for hedge funds. Obviously we have a lot of Cayman master feeder structures that we see. There are some significant or could be significant compliance costs, extra filings, things of that nature when you enter into an offshore potentially withholding when you enter into an offshore structure. So just wanted to go through that in a little bit of detail here. Very standard structure that I'm showing you on the screen. You have your master fund down below. It's usually a Cayman partnership or Cayman tax as a partnership. The US people will go through a domestic LP US feeder and the tax exempts and the foreign folks will generally come through an offshore feeder, which is usually Cayman vehicle taxes. We see it a lot with Cayman, but a vehicle tax as a corporation.

So just a basic structure here.

Mark Stahl: One of the main reasons why the tax exempt comes into the offshore fund is because funds tend to go on leverage and that would create what we call UBTI, unrelated business taxable income. And that will cause a tax exempt who might be exempt from tax to have to pay tax at a high rate at a very low amount. So usually we do see a lot of US tax exempts come into the offshore feeders because of a UBTI issue because of the fund leveraging. Just keep in mind as they come into the offshore feeder, they are subject to the 30% withholding that will be done on the offshore feeder. The offshore feeder doesn't pierce and the withholding on the US dividends will be withheld a 30% on a Cayman Island fund due to there's no treaty between the US and Cayman.

Brett Cornell: Thank you, Mark. And just quickly to highlight some of that, Mark's kind of talking about the 1042, 1042S reporting, withholding on dividends. So if you have US dividends being allocated to a foreign person, there could be a withholding obligation there. 5471s, these are some forms that we see the required or potentially missed and just not necessarily known about. And there's some issues with the penalties surrounding these forms, but a 5471, the US person owning over 10% of a foreign corporation, you might have that with the foreign corp structure, 8865s for some interest in foreign partnerships by a US person. 926, if you're transferring cash, US person transferring cash to a foreign corporation. And then your 8621s, those are the PFICs that most people enjoy so much. Really the main impact here is there's some draconian penalties for missing these types of filings. So you want to be aware if you're in a foreign structure, just kind of what your obligations are as it relates to these specific filings.

There could be penalties of up to $10,000 for late or incomplete forms per year. And really the kicker is if you miss these forms, the return is considered incomplete. So your statute of limitations never starts and therefore the IRS can come and take a look at your entire return in perpetuity as opposed to the standard three year limitation.

And then just very quickly, I just wanted to mention 1446 F withholding. This is going to be applicable if you're a foreign vehicle that's trading PTPs or assets that fall into the regime for Interest Real Property Tax Act. Really main takeaway here is if you're involved in investing in real assets or PTP style investments, there is a 10% withholding on the proceeds when you go to sell those investments if you're a foreign person. So this is something that not a lot of folks are really familiar with and it could be a surprise. There are exceptions and kind of ways to potentially get around or mitigate the withholding, but that needs to really be brought to your tax advisor proactively because we have seen clients that have fallen under the trap of 1446F withholding, had major withholding done on them improperly and it's taken a long time to go back to the IRS and get those monies refunded.

We have had success with it, but it's not a quick process. So with that, that's really all I had planned to cover for our hedge fund considerations. So please feel free to reach out directly if there's any further questions. But at this time I will pass it along to my colleague Phil Begnesian to go over the management company and own our planning considerations. So Phil.

Philip Bekmessian: Thank you, Brett. Hi everyone. My name is Philip Bekmessian. I'm a senior manager in our financial services tax group. I've been with the firm for just over 11 years and I work in our New York City office. So for my segment today, I will cover several management company planning items and updates. Managers are consumed throughout the year with fund and investor related matters and planning for the management company itself may get pushed aside. So my goal is to highlight key areas that are worth revisiting to avoid surprises when you enter your next tax season. So we'll start with income and expense planning items. On the income side, management fee waivers are an efficient tax planning tool available to management companies and they're predominantly seen in private equity fund structures. Management fees are typically charged at 2% of invested or committed capital and they're treated as ordinary income subject to self-employment to the manager.

So a management fee waiver allows the manager to give up all or part of that fee in exchange for a profits interest in the fund. So a properly structured fee waiver can accomplish two things at once. It can be used as a way to defer income recognition and then potentially convert what would be ordinary income to capital gain treatment depending on the underlying activity of the fund.

So how do they work? Management fee waivers are structured as profits interests under RevProc 9327. And the way that it works is that the value of the waived fee is treated as a cashless contribution into the fund for the GP. Now the IRS issued proposed regulations back in 2015 that address when certain fee waiver arrangements would be considered disguised payments under IRC section 707. And these proposed regs were never finalized. However, the IRS does view them as current law and audits against them. So managers should structure, document and review all waiver arrangements for compliance with the proposed regs.

Mark Stahl: So Phil, I think here just -

Philip Bekmessian: Sorry, go ahead. Sorry go ahead Mark.

Mark Stahl: Sorry, just to start to interject here for a second. I just want to elaborate your point. I think one of the main things that people have to realize when they're doing a management fee waiver, it's also doing dumb for a service. So it'll also be subject to the 1061 rules, as well as having this waiver, it has to be at risk. It can't be at the end of the day where the manager's not at risk where if the fund doesn't make money, they're going to get some type of fee, whether it's an admin fee or whether it's a management fee being paid at

Philip Bekmessian: The

Mark Stahl: End. I'm sorry if I'm stealing something that you can about to

Philip Bekmessian: Say.You're still on my funder, Mark.

Mark Stahl: Go ahead and I'll let you elaborate on that, but I think that's another thing that keep that in mind.

Philip Bekmessian: Let me elaborate quickly. So to have your fee waivers respected, they must be irrevocable and made in advance of when the management fees would've been earned. So we recommend building waiver provisions into your partnership agreements to satisfy this requirement. And I think the most important requirement that Mark was beginning to discuss is that the

Alyssa Rausch: Profits

Philip Bekmessian: Interest that the manager receives must carry what's called significant entrepreneurial risk. So what does that mean? The profits that are paid to the manager associated with that profits interest must be paid from future profits only. It can never be fixed or determinable. And there has to be a real chance that the manager receives nothing if the fund were to underperform. Now that's a practical downside of management fee waivers. Many management companies rely on management fee income to fund operating expenses of the management company. When you waive the right to that fixed fee and the fund performs poorly, you lose that cash flow. So management fee waivers may not be a viable option for management companies that rely on fee income to fund operating expenses. And the last point that I want to make on management fee waivers is that they're also beneficial to certain types of limited partners, particularly limited partners that are partners in investor funds.

So as Brett described earlier, fund level expenses that are allocable to limited partners and investor funds are subject to 212 limitations and are essentially non-deductible for non-corporate taxpayers. When a waiver's present, instead of those limited partners sharing in a non-deductible management fee expense, they're simply allocated less taxable income for the portion that's reallocated to the GP for the profits interest. So just to recap, management fee waivers, a very effective way to defer and convert the character of income. However, it's critical to comply with the IRS guidelines to avoid IRS challenges or

Mark Stahl: Even

Philip Bekmessian: Re-characterization of that income. Mark, did you want to add anything to that?

Mark Stahl: I think to your point, we see it a lot more in the private equity space than we see it in the hedge fund space based on all the characteristics that you mentioned and the main thing being cash flow and being that hedge funds are also open market, meaning open funds versus closed end funds for that matter, that's why I don't see a lot from the hedge fund space. But from that matter, those are the things you have to keep in mind. Like you said, the 212 deduction is one of the reasons why we see that more often. So of course if you' taking the fee waiver, the LPs do kind of like it because the management fee is a fee that they cannot deduct, especially if they're an investor fund or in the private equity fund, that's why they like it more. And we see a lot more on the private equity side is because the general partner has to also usually have a commitment inside the fund alongside their investors.

And the management fee waiver is a tool that's used to fund their commitment for that matter. That's why we typically see a lot more on the private equity side versus the hedge fund side where there may not be such a requirement for a hedge fund manager to actually have a commitment of 2% of the fund.

Philip Bekmessian: Absolutely. Thanks Mark. Okay. Switching gears to some expense items. So when we're working through a management company expense planning, we want to try and project out taxable income and loss, not just for the current period, but for future periods as well. If a manager projects current year taxable income and subsequent year losses, it may make sense to accelerate certain expense items. Now, cash bonuses happen to be an expense item that managers kind of control that timing on. So in a profitable year, owners may choose to accelerate cash bonuses and to accomplish this for an accrual basis taxpayer, those bonuses should be fixed by year end and properly accrued and then paid within two and a half months of year end to take that deduction in the same year. And fixed is the catch. So if the bonus pool is still discretionary at year end, you don't have a good accrual, you can't take that deduction in the same year.

Now for a cash basis taxpayer, the methodology is much more straightforward. It's cash out the door by year end to take that deduction in the same tax year.

Okay. Another lever that managers control the timing on is bonus depreciation and section 179 expense. So the one big beautiful Bill Act made 100% bonus depreciation permanent for all assets placed in service and acquired after January 19th, 2025. So your furniture, tech, workstations, certain qualified improvement property is all eligible for full expensing. But again, full expensing isn't automatically the right answer. Owners need to evaluate current and future year profitability to determine the most efficient depreciation methods to apply to their fixed assets. Owners should also be aware of state conformity issues related to bonus depreciation. Many states do decouple from bonus depreciation rules, which results in an add back at the state level. So for states that decouple from bonus depreciation, owners can model section 179 expense on those assets. For tax year 2026, the federal 179 deduction is capped at 2,560,000 and it begins to phase out once the qualified additions for the year exceed 4,090,000.

And section 179 also carries state limitations of its own. So I have two pretty clean examples. New York State decouples from bonus depreciation, but it conforms to section 179. So a management company with substantial New York state apportionment may consider electing section 179 on those assets to reduce that federal and state depreciation difference. Other states like California cap the amount of allowable 179 you could take in a given year. California specifically caps that deduction to $25,000. So again, it's important to model both before you lock in a method.

Mark Stahl: If I may just also add Phil to this matter here, especially if somebody is, let's say building out a space, you're going ahead and you're renting new space in a building and you want to build it out. Obviously now we have bonus depreciation, but I would also say that cost sex studies have proven very valuable in this area, that it actually takes everything into consideration what's considered leasehold of improvements over 15 years, what is considered furniture and fixtures, what is considered software, which is obviously depreciated over five years for software. Software is three years, but computers and equipment for five years and furniture and fixtures over seven years, which are getting a better answer that could be very important, very useful, especially from a state side, especially if you're in a state like New York and California that are decoupling where you could get a bigger deduction using a cost ex study versus just focusing just on the bonus depreciation from federal standpoint and then have huge add-backs from a state perspective.

Another issue where we see a lot coming in is when a management company wants to buy an airplane and then the airplane costs a lot of money, they think there's going to be bonus depreciation on it because you're entitled for the first time you own this plane and the first time you're buying it, you're entitled to bonus depreciation. And then the other thing to keep in mind is the add back on the state side. And people have gotten a lot of surprises on the management company that own planes that when they add back the bonus depreciation, there's a huge state liability that comes through. And sometimes that could be overlooked to keep in mind that the state decouplings on bonus depreciation before you do anything and just say, oh, federal allows it. It could bite you, especially if there's a huge add back from a state perspective.

Philip Bekmessian: Thanks, Mark. Okay. Meals and entertainment. So there is a notable change for tax year 2026 and it may raise the cost of running your office. So beginning in 2026, meals that are furnished for the employer's convenience and costs associated with an employer operated eating facility are now generally non-deductible. These expenses were previously 50% deductible through tax year 2025 and now are generally fully non-deductible in 2026. Some examples of meals that are furnished for the employer's convenience, it's really about the intent of the meal. So if meals are brought into the office and they boost employer productivity, so overtime meals, meals that are brought in during mandatory trainings, late night dinners, these are all meals that keep employees on the premise. They keep them working. These are now fully non-deductible heading into 2026. And an example of an employer operated eating facility would be we lease office space within that office is a kitchen or cafeteria.

We contract a third party vendor to operate that cafeteria, provide meals to our employees before and during and after the workday, keep them on the premises, keep productivity high. The expenses that are associated with that eating facility are now generally non-deductible where again, they were 50% deductible in the prior year. And I feel like this one's going to hit businesses pretty hard because free food and stock kitchens have basically become the standard across all offices. So it's something to look out for heading into 2026. Now, some items that haven't changed are good business meals. So meals with your clients, prospects, vendors, those are still 50% deductible. Company-wide functions are still generally 100% deductible, so your holiday parties and firm outings. And then entertainment is still generally fully non-deductible. However, I do want to point out that if you purchase a good business meal separate from the entertainment purchase, it may still qualify for that 50% deduction.

An example I like to use is I take a client to a Knicks game, I purchase the tickets for the game, those tickets are non-deductible. We stop for dinner before the game, that purchase is made separately. That may still qualify for that 50% business deduction. So just something to look out for. Meals and entertainment is so funny. It's grouped into one category and the deductibility of meals and the types of meals is actually all different. So it's important to maybe keep separate buckets on your books to substantiate those expenses when heading into the next tax year. With that, we have our next polling question. So beginning in 2026, meals provided in an employer operated eating facility are 100% deductible, 50% deductible, fully non-deductible, or deductible only if catered. Give everyone one minute.

Mark Stahl: Phil, there's a question out here. Do management fee waivers create tax basis for GP members? So to the extent that you're receiving taxable income, obviously part of the waiver that you're getting from a tax perspective is taxable income. That will create tax basis for the GP as taxable income is earned. Accrued fee waiver, everything's unrealized. Obviously if it's unrealized and not being taxed, that will not create basis. But to the extent you're receiving taxable income, taxable income does create tax basis for the GP waiver.

Philip Bekmessian: Okay, thanks Mark. All right. Beginning in 2026, meals provided in an employer operated eating facility are fully non-deductible. So 66% roughly. Got that one right. It's good to see. All right. So we just worked on engineering a taxable loss at the management company level through income deferral or accelerating certain expense items, but does that loss actually land in the same tax year for the owners? Owners are hit with so many hurdles before they can actually take a business loss. You have your 704D basis limitations and your 465 at risk limitations, your passive loss rules under section 469, and then we can take our business loss, right? Well, section 461L says otherwise. So the excess business loss limitation was scheduled to sunset in tax year 2028. The one big beautiful Bill Act made this provision permanent. So it's no longer a rule to wait out. Owners need to include this in their annual tax planning going forward.

And what 461L does is it caps how much business loss an owner can use against non-business income. The 2026 thresholds are 256,000 for single taxpayers and 512,000 for taxpayers that are married filing joint. And I just want to note that that's actually down from 2025 where the thresholds were 313 and 626,000 respectively. So it's become easier to create a business loss at the entity level and more difficult to actually take that business loss when we get to the individual level.

And I think for... Sorry Mark, did you want to say something?

Mark Stahl: No, I'll let you finish your thought and then I'll -

Philip Bekmessian: I think 461L takes this room in particular because managers carry heavy non-business income, maybe from their portfolio gains or carried interest that's capital and character. These business losses from the management company can't shelter past those 2026 thresholds. And the deductions that are non-deduct, the excess business losses that you can't take in the current year, they aren't lost. They do convert to an NOL and can be carried forward to offset future taxable income.

Mark Stahl: So if we just elaborate here now on 461, this applies to management companies, any type of trade or business. 461L excess business loss limitations will apply. This also applies to trader funds, to the GP of trader funds, that the 461L business loss limitations will apply to that. If you're considered a trader business for that matter, it will apply to you as well. So trader funds, 475 funds, mark to market funds, also 461L will apply. There's one additional place where 461L could apply even though you're an investor fund. And if you're an investor fund and you're a GP and you're taking PTET, your pass-through entity tax, and it's being reported on line one and you're taking that as a Schedule E on your 1040 getting an ordinary deduction, that would also be subject to the 461L limitations. And 461L is an aggregation. It's not one by one.

Each entity is its own. Each entity stands alone and you then say, "Okay, can I take deducted or not?" You aggregate all your business income against all your business losses. So even if you're a trader fund, that means if you're a trader fund, that means all your interest, all your dividends, all your capital gains, all your expenses, everything gets lumped together and you come up with your net taxable number, and that is considered your trader business income, not just your expenses or a piece of it. Everything in a trader fund or 475 fund is considered a trader business, and that gets aggregated together if you're also in a management company, you add everything together and either have net gain or net loss. Now, if you're going to have a net loss greater than in 2026, greater than 256,000 if you're single or greater than $512,000 if youre married filing joint, it could only offset other capital gains, other dividends, other interest, other wages up to the 512,000 if you're married following joint or 256 if you're single.

Anything in excess of that will become an NOL into future years. So the question that we get a lot is, should a GP then elect into PTET if I know I'm going to not be able to take the loss or this expense in the current year? And the answer is yes, because under the PTET rules right now, and I'm sorry if I'm instilling a little bit from Melissa, you're capped right now at either $10,000 depending on your income or a $40,000 cap. Now, anything above that is basically not going to be able to be used. It's like thrown in the garbage. Using PTAT, you might be limited the first year, but then the second year turns into an NOL and that goes against 80% of your future taxable income, which you will be able to deduct. So even when it comes to PTET, you might not be able to deduct it in the first year.

It still is a viable option that you'll get in the future versus not electing into PTET at all. And then the whole deduction goes in the garbage if you're above $10,000 cap or the $40,000 cap, depending where your income is. Back to you, Phil.

Philip Bekmessian: Thanks, Mark. All right. I'll try and... We're a little bit tight on time, so I'll try and breeze through the 199A slide since it probably doesn't really apply to too many people on this call. Section 199A, the qualified business income deduction was introduced through the Tax Cuts and Jobs Act and has been effective for all tax years after 2017. This provision was scheduled to sunset after tax year 2025, but was also made permanent through the One Big Beautiful Bill Act. And what the provision has done is it's given owners of pass-through entities an extra deduction for 20% of their qualified business income. Your QBI includes income loss from any domestic qualified trade or business, and that QBI deduction does begin to phase out once your income thresholds exceed a certain range. Ranges are on the slide, so I won't cover them, but once the income exceeds those thresholds, they're capped by W-2 wages paid by the business and unadjusted basis of qualified property restrictions.

Now, 199A has a second much more restrictive limitation that applies to owners of specified service, trader Businesses or SSTBs. And that SSTB category covers a broad range of professions, accounting, law, financial services, investment management, essentially everyone in the room. And once those income thresholds cross the phase out range for SSTBs, that QBI deduction goes to zero. So there is no additional test. Where does QBI matter for owners of management companies? It matters for owners with less income below those thresholds or for their other genuine non - SSTB pass-through income. In 2026, the One Big Beautiful Bill Act did introduce a new $400 deduction for a minimum deduction for taxpayers with at least a thousand dollars of active QBI in businesses that they materially participate. SSTB income can support the minimum deduction, but again, once those taxpayers are above that phase out range, that minimum deduction also goes to zero.

Sorry, I want to leave time for Alyssa here, but we have a couple more slides. Okay. Fan favorite, the pass through entity tax or PTAT. So PTET is still the most effective way for owners to work around the SALT cap and it survived the one big beautiful bill act intact. So PTET is still available in 2026 for management companies and other entities that are taxed as partnerships and S corporations. And what the PTAT does is it essentially shifts the tax from the owner to the entity where the entity deducts it as a 162 business deduction on their federal returns. The benefit lands federally through lower K-1 income to the owners without ever touching their SALT cap deduction. Now the 2026 SALT cap is 40,400 for both single and joint filers. And that increased SALT deduction begins to phase out once modified adjusted gross income exceeds 505,000.

Again, this is the same threshold for single and joint filers. So it's basically a built in marriage penalty. When modified adjusted gross income exceeds 606,000, that SALT cap reverts back to 10,000. So this is why PTED matters so much for your owners. Many of your owners are already above those thresholds. So the increased itemized SALT cap does nothing for them.

PTED elections are state by state with hard deadlines and payment requirements, went through a few of them earlier. So it's important for your owners to review each one to capture this deduction properly. Missing state elections can mean a full year without the SALT cap workaround as many states offer no relief for missed elections. Underpayment of required installments can mean high penalties, reduced credits, or even invalid elections depending on the state.

Mark Stahl: I would just add here, the key thing, especially for some of us is once we're in New York, you have to be careful for that 315 deadline when they want you to file. I know there's been legislation out there whether they want to extend it to 915, but as of now, I believe it's still at 315. And California actually has come out a little bit with their payments even though the election is the following year by extension time, but they do require two estimate payments. One is on June 1st. And one of the things that they used to have is if you didn't pay in at least 50% of prior year's estimate, you were kind of out of the program. They've actually made adjustments for that, that they're adding a penalty to it that you won't... I believe if you're late, you lose about 12.5% of your credit, similar to Connecticut, which only gives you 87 and a half cents on the dollar.

Okay, sorry, going to a polling question.

Philip Bekmessian: No worries. Next polling question. The primary benefit of the PTED election is to lower the state tax rate, B, work around the federal SAL cap, C, eliminate state tax, or D, defer federal tax. Give everyone 30 seconds hopefully with this one. All right. I think -

Bella Brickle: We got to give everyone just a little bit longer. Only half of folks have responded. Let's give them just 10 more

Philip Bekmessian: Times. Thank you.

Bella Brickle: All right. Last chance to make sure you select an answer. It doesn't have to be the right one to get credit and hit the submit button. All right, you're good to go.

Mark Stahl: I would also just say why... Sorry, I would just add here on PTAT. Usually we do not find this that a fund is electing in for the PTET election. It's usually only done on the management companies and GP entities. Now we also see sometimes GPs invest in and they come through their family limited partnerships to capitalize on this. So they also come into that as well, but we typically do not see this on the fund level. It's usually only on the GPs as well as the management company.

Philip Bekmessian: All right. The answer is work around the federal SAL cap, so 78%. Thank you for answering that. And I will move on to my last slide. I just want to provide a brief update on the self-employment tax limited partner exception. I'm sure many of you are aware that there are several ongoing cases related to the limited partner exception for self-employment tax under 1402 where the IRS has challenged certain taxpayer positions related to this exemption. So the position that's taken is that many management company owners or other business owners have taken the position that if they're a limited partner in certain structures, that their distributive share of partnership income should be exempt from self-employment tax, excluding their compensation in guaranteed payments. The IRS has come back and challenged this in several cases. So I just want to provide a brief update as we're going to take a deeper dive into this in one of our upcoming webinars.

But the latest developments is that on August 12th, 2026, the Fifth Circuit, which governs Texas, Louisiana, and Mississippi revised its opinion in the Serious Solutions case. The revised decision states that a limited partner could play no significant role in management or control of the partnership and the circuit left room for certain partners to participate in non-managerial activities. Now, that's certainly a step back from their January opinion, which we thought gave taxpayers a bright line win, stating that limited liability under state law was enough to constitute a limited partner under this exemption.

Similarly, on September 17th of the current year, the Second Circuit unanimously affirmed the tax court's decision in the Saraban case, holding that the exception applies only to partners who do not run, manage, or control the business. Now, the Second Circuit governs entities domiciled in Connecticut, New York, and Vermont, but you can see the pattern here. Both circuits are beginning to apply a similar, not identical management-based test and both circuits leave room for certain service partners to potentially qualify as long as their activities are non-managerial and non-controlling. So it doesn't look like it's an all or nothing approach. A partner who runs or controls the business may no longer qualify for this exemption, but one whose role is genuinely non-managerial may still be exempt. So the action plan going forward for fund managers is to assess each partner's actual role, document who manages and who doesn't.

Because one thing it seems certain is that, at least in these jurisdictions, is that state law limited partner status alone is not going to protect partners from seek a tax, again, in these two jurisdictions. So I wanted to highlight this because management companies do at nine 15 of 2025. One of these rulings came out right after that filing deadline. You may have open positions that need to be revisited that you may have taken in 2025, may not want to take that risk on in 2026. So just something to put on your radar heading into the next tax year.

Mark Stahl: Phil, that's an amazing point. Where do people go from here at this point, especially with the ruling coming out in the second circuit, which is New York where a lot of our management companies are based. What happens now? I know in 2026, right afterwards, there was a whole concept around what do the individuals do? Do they have to do disclosure? Don't they have to disclosure on a Form 8275? And that was the issue that we were dealing with in 1040 season. I think this question's also going to come up depending where this goes. If this goes to Supreme Court, obviously this thing is still open or have we run the gamut already with this LP exception? So with that said, what happens if we don't hear anything in 26 or we don't hear anything even in 27, what to do? What happens there? Will the partnerships themselves have to put disclosure?

Will they take a position and say everything is now subject to self-employment tax? Or will they also be subject perhaps to disclosing to the government, "By the way, we're taking this position and it's maybe contrary to case law that's in my district." So those things are open and those things that we're monitoring right now for 2026. And I'll shamelessly plug right now that our part two regulatory and IRS enforcement updates, which will be on Thursday, November 12th, will address this issue as well. So please join us for that as well and hear a little bit more on the Sorban and other hot updates on the IRS side.

Philip Bekmessian: All right, thank you. With that, I'll turn it to Alyssa to cover some of the individual planning items. Thanks everyone.

Alyssa Rausch: Good afternoon. I'm Alyssa Rausch, tax partner within EisnerAmper's private client services tax practice. I work with individuals and families on tax planning and tax compliance, including hedge fund partners and executives. Today, I'm just going to share a few tax planning ideas for individuals in the hedge fund space. Really, when it comes to tax planning, it tends to fall into various categories and really how involved and active you are in each category really depends on your individual and family goals. So with that, and some of the categories include charitable giving, portfolio tax efficiencies, what you want to do in the way of trust and estates planning and so forth. So with that, we have our first polling question, which is individual income tax strategies include A, charitable giving, B, retirement planning, C, portfolio tax efficiencies, or D, all of the above.

So in order, as people are waiting, I'm going to kind of get started on the next slide because I know we're kind of running out of time. So basically as the year comes to a close, it's really a great time to think about donating to charity in order to reduce your tax bill. You can either donate directly to a charitable organization, but just make sure that it's considered a 501 organization and the IRS offers tools on their website, which basically allows you to determine if the charity is qualified. The other thing you could do is set up what's known as a donor advised fund, also known as a DAF. A DAF is a separate account managed by a sponsoring organization such as Fidelity Charitable or Schwab Charitable. And basically the way it works is you establish a DAF account, you then move money the money will then grow tax free.

Before that, you would then receive a tax deduction and then the fund managers would then go ahead and move the monies to various qualified charities. I'll take one moment break just to say that the answer is all of the above. So great job for those who answered that correctly. Okay, so we'll move on to this. This will be my only slide. I'm just going to cover each bucket and just give you a few tax planning ideas within each point here and bucket. So continuing on with donor revised funds, what's really nice about them and what has made them increasingly popular over the years is the fact that you can take and claim an immediate tax deduction while at the same time have an opportunity to decide where those monies are going to go. The other thing that you're able to obtain with the DAF is if you donate securities to a donor revised fund, you receive a double deduction, double benefit.

And that is one, you receive a deduction for the fair market value of the securities and two, you don't have to pay capital gains tax on the appreciation. So the advantages of DAFs are one, really the ease of administration. There's no additional tax filings and there's relatively low admin fees. The disadvantage is the fact that once you transfer the money into, or your property into a donor revised fund, you lose all legal control over those assets. In two cases, Pinkert and Fairborn actually highlight those very issues. Another way to donate to charity is to set up a private non-operating foundation. A private non-operating foundation example would be the Gates Foundation. Of course, foundations can come in all shapes and sizes and basically we recommend that if you're looking to donate between five to $10 million into a charitable vehicle, you may want to consider setting up a private foundation as an option.

Private foundations are separate legal entities and they are considered tax exempt organizations. The advantage of setting up a donor advised of a private foundation is the mere fact that you don't lose any legal control over the assets. The disadvantage is really the things that are involved. There's a lot of work involved such as you have to appoint a board of directors, set up a separate legal entity. There's some scrutiny over private foundations and also the hurdles to surpass to receive the deduction are a little bit higher.

The way a private foundation works is basically you have to set up a new entity, you have to appoint a board of directors, you then transfer your money or securities into a private foundation, claim a deduction, the money grows tax free with the exception of a roughly 1% excise tax, and then the founders and the board members then go ahead within the family and distribute the money. Regardless of how you decide to donate, one thing you want to keep in mind is the importance of bunching charitable donations. And what that means is that if you're considering whether or not you want to donate $25,000 over a four year period or donate in one year, in the first year, the whole $100,000, you may want to consider doing that and that is what is bunching. So the reason why it's become critical, especially now with the new tax law, is there's some new hurdles that you have to surpass to even get the charity that you donate to become deductible.

So it's something specifically you want to kind of think about and look at as you come to the year end. The other thing is -

Mark Stahl: Alyssa, may I elaborate?

Alyssa Rausch: Yes, of course.

Mark Stahl: Sorry, if I may just elaborate one last point on this, especially for the general partners here in this group that's listening. When you're going to donate securities, now if you have regular securities that you bought in your regular brokerage account, obviously everything has to be long-term. You want to be long-term in order to get the fair market value of it versus a short-term property where you're only going to get the cost basis. So if you really want your bank for your buck, it has to be long-term property. Now with that said, if you're going to take a distribution out of your fund, from that matter, you have to also keep in mind the 1061 rules, right? If the property did not hit three years, then it's considered to the GP, and especially if it's from carrier, not capital, then it's going to be re-classed as short-term and it's going to look at what it is in the holder when they're giving it.

So if let's say, for example, you took two-year property and you donated it to the charity, you're going to get a deduction to the cost basis, not the fair market value. So do keep in mind if you're taking a distribution from the GP, we want to take three-year property and it has to be three-year property in order to get your bank for your buck into a DAF. So just keep that in mind. Sorry, back to you, Alyssa.

Alyssa Rausch: Okay, great. Great point. Portfolio tax strategies. One thing I just want to point out here is that EisnerAmper does not provide investment advice, and we always recommend that you look at your full picture and not make a decision solely because of tax reasons. I always like to bring in my client's financial advisors on the call when we were talking about portfolio tax efficiencies. So with that said, one thing to do on your level with your portfolio is to harvest losses. I know you're doing a fair amount of that at the fund level, but also looking at your portfolio, it's a great time to download your realized capital gain and loss report, see where you stand, and talk to your investment advisor about what opportunities there are to potentially sell any securities that are showing unrealized losses to potentially reduce that capital gain. A lot of times what people try to do, portfolio managers try to do is they want to rebalance your portfolio, and so they'll take the proceeds from those lost securities and try to purchase substantially identical securities.

Just make sure you don't run afoul to the wash sale loss rules that Brett discussed earlier, because otherwise then those losses would be disallowed potentially. The other thing to do is evaluate your ratios, and that is basically taking a look at your portfolio at a different angle. Look to see how much within your portfolio are you selling your stock using more than one year, one year and a day above? How much of your securities are considered short-term versus long-term? Because long-term capital gains are taxed at that maximum rate of 20% versus short-term capital gains or the maximum tax rate is 37%. But just by merely holding your stock for more than a day above a year, you're able to save 17% in tax savings. So that's low hanging fruit. The other thing is when is the last time that you took a look to see which companies are issuing to you qualified dividends versus non-qualified dividends?

Similar to long-term capital gains, qualified dividends are also taxed at that maximum 20% versus non-qualified dividends. Then the other thing is with interest, how much of your interest is composed of tax exempt interest? Interest, as you know, is taxed at an ordinary rate. And then further of that tax exempt interest, how much of it is sourced from muni bonds coming from your resident state? So there may be a reason why most of your muni bonds are maybe not from your resident state, but you just want to check to see opportunities there. Qualified opportunity funds, this was a program that was set up to rebuild low income communities. And what the IRS did was they designated certain zones throughout the country that are marked specific qualified opportunity zones. Qualified opportunity funds are entities that are structured as either partnerships or corporations, which own more than 90% of its assets in these qualified opportunity zones.

So what this means for you is there's opportunity here for you to defer your capital gains or potentially excluded, especially under the new program. There's two programs right now going on. There's what they term the 1.0, which is the old program, and then there's the 2.0. So I'm going to start off to explain the 2.0 real quickly on how this kind of works. Basically, let's say a couple years ago you purchased Apple stock. We'll say you purchased it for nothing, just to keep things simple and the cost basis is zero. It's worth right now $1 million, so you sell it for $1 million. At that point, you would then have a realized capital gain of $1 million unless you decide to take those proceeds and reinvest it within 180 days into a qualified opportunity fund, at which point you can then take the gain and defer it for up to the five-year mark.

You have to have held it for five years. Then 10% at that point would be excludable, that's already 100,000 that's excludable of that million gain. And then the other $900,000 would have to be recognized in the fifth year. Then if you hold that qualified opportunity fund for more than 10 years, then any appreciation on the fund is actually excludable. And this all happens by way of a basis adjustment, but at the end of the day, this is essentially what the result is. Under the new program, there's some other nuances such as there's a 30-year rule as well to look into if you're looking into getting involved. This is for investments that are starting in 2027. Now, starting effective December 31st, 2026, if you did defer capital gains in prior years under this those gains in.

So it's a really great opportunity which is coming up to do some tax planning with your financial advisors and your tax advisor to see what things you can do to try to reduce the impact of that gain. And that leads us to the next idea. This is disposing of passive losses. So what this is, is let's say you invested in a business, you decide to put in $100,000 in your friend's business, and the first three years the business is not performing well. It's just starting out, it's operating at a loss. And we'll assume that the business is a partnership. So those losses that are allocable to you in the first three years are going to be considered passive to you. And what that means is those passive losses can only offset passive income. So if you have no other passive income, then in theory, and every year you generated...

There was about $10,000 allocable to you and there's a three-year period, you'd have $30,000 of potential losses that are stuck and can't be used. So this is an opportunity to take a look to see if you have any of these types of losses. Ask your tax advisor to run for you their passive loss carryover schedule, and you can take a look. And if you're interested, another way to release those losses is to dispose of your interest in it. So that's one opportunity. So if you going back to the qualified opportunity fund and the old program, if you are to recognize income in 26, you know what the gain is, then you potentially can find any losses from passive losses, you could potentially try to release some of those losses to offset that gain. So that's one opportunity. Some people might say, "Well, I think in three or four years from now, the business is going to perform very well, and so I'll generate and receive allocable passive income, and then I can use those passive losses to offset that passive income." So that might be...

It's just an item of consideration. The other thing is the concept of, let's say if you own a side business or your spouse owns a side business, to think about whether or not that business qualifies in order to claim the qualified business income deduction, which was mentioned earlier by Phillip, and this is a 20% deduction on your income. I'm not going to go into specifics on it, but it can be very powerful if you're not considered an SSTB and the business is outside of that realm, then you could really potentially benefit from it. The other thing I see a lot is REIT dividends. REIT dividends are also eligible for a 20% deduction, just to check to see if you were issued any of these types of dividends.

The other concept is if you're interested in going into renting out rental properties and trying to claim losses against other income, one thing you could do is buy a property and use it to rent out short term as short term rental property. And basically there's very specific provisions and parameters to meet this, and we're not talking about the typical property that you buy as a vacation home and then rent out over the summer or you rent out for a lease of more than a year. This is more for property that is going to be purchased, not to be used for personal purposes and really to rent out on a short term basis, kind of like through an Airbnb type of situation. The average period has to be seven days or less during the year and you have to materially participate in the operations, which means you have to spend more than 500 hours on the activity.

So this typically works in a fact pattern where one spouse works full-time, the other spouse does not, and the spouse is the one that manages the properties. Where the benefit really comes into play is when you can claim depreciation and do a cost segregation analysis where you can write off a large piece of the purchase price of the property. Going into trust and estate planning here, some things that I see a lot with hedge fund partners is they'll often try to set up a grantor trust and early on they will transfer their interests, their LP interest into a grantor trust. You want to try to do that as early as possible so you can get more appreciation out of your estate. Grantor trusts, that is a technique to help with estate tax planning. For income tax planning, grantor trusts are basically disregarded and the grantor, the one person who sets up the trust is subject to pick up all the income tax consequences and pay the income tax on it, which means that it helps make sure that the trust itself does not dilute.

The other thing is non-grantor trust planning. That's also an area that you might want to look at. A lot of people like this area just because for income tax planning, non-grantor trusts are basically separate legal entities and with it come many of the deductions that individuals are entitled to, which means there's opportunity for planning there where perhaps you could maximize on the state and local tax deduction. So as we know the maximum is 40,000, but then it gets reduced down to 10,000. So some people say there's some planning opportunity there. Other thing to note is qualified small business stock. There's opportunities to stack the exclusion amount, which right now it depends on the year in which you bought it, but it could be either 10 million or 15 million. So let's say that you own QSBS and you know that it'll appreciate to $20 million and we're referring to stock that was acquired a certain date, so the exclusion amount would have been the greater of the 10 times the basis or $10 million.

Basically you could gift half of that stock to a non-grantor trust and both the trust and you sell it and then both of you are entitled to a $10 million exemption exclusion.

Bella Brickle: I just have to move it to this final poll as we are now at the end of the time that we had promoted.

Alyssa Rausch: Okay, sure.

Bella Brickle: If you are able to keep presenting on your topic, you may do so while we give the attendees a minute here to get in their last polling question.

Alyssa Rausch: Of course. Yeah. Harvesting losses is what type of strategy? A, compensation planning, B, trust and estate planning, C, portfolio tax efficiencies, or D, charitable giving. So I'll just continue on while you're going... Or Mark, would you want to continue?

Mark Stahl: I just wanted to just interject here for a second and just remind everybody that this year we're usually a three-part series. This year we're actually going to be a four-part series on our webinar, our year-end planning webinars. So once again, part two, regulatory and IRS enforcement updates will be on Thursday, November 12th. Part three, state and local tax and international taxes updates on Thursday, November 19th. We will take a break for Thanksgiving weekend and we'll come back with part four, year-end considerations for private equity funds and portfolio companies on Thursday, December 3rd. Alyssa, back to you.

Alyssa Rausch: Okay. Should I continue now? So other ideas that you can do, and I'll just kind of go over just maybe two more. One is just for planning for the mortgage interest limitation, that it's still the case where if the principal of your mortgage is more than 750,000, then your mortgage interest starts getting limited. So if you're looking to buy a home, consider maybe taking a mortgage up to the 750,000. If you have other funding sources to try to use those so that you can receive your full deduction. And I think that that's all for now. I think since we're going over, I think we'll conclude there.

Bella Brickle: Great. And I know Mark kind of already covered that this is part one of a four part series. Mark, do you have any other closing comments you want to share?

Mark Stahl: No, I just want to thank everybody for joining us today. I hope you found it informative and looking forward to having you and hosting you on our future parts.

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