Investors won't step near a mutual fund if it doesn't check every financial objective off their lists. Managers do their due diligence behind the scenes, all to help limited partnerships benefit over the long haul. When it comes to structuring these funds through tax season, though, are you as confident as your clients think you are?
Tax code is a hard language to decipher, but investment funds carry more complications than rookie managers are prepared to handle. Unlike other business-related compliance, investment funds come with quirky tax complications.
So whether you're managing a small fund with a single limited liability company or investing internationally, managers need to stay sharp on any pain points. Managers who fail to do so will almost certainly dull the momentum any investment gains.
A Playbook for New Fund Managers
Let's say a small fund starts off with just one LLC and runs both operations and investment activities through it. This setup gives operational income to the investors, who might then need to pay tax on this amount. International funds require even more oversight because U.S. income may be taxable to foreign investors.
While preparing for tax season, managers must keep two factors at the forefront of their minds: First, there are key differences in investment fund management that can complicate taxes; second, a mistake anytime during the process creates the potential for a costly situation to be untangled. Here's how to avoid those mistakes:
1. Hire the professionals. Get ahead of the process by calling the experts first. It's simple, but it works. Engage experienced attorneys to help form your fund structure. They can keep you abreast of potential problems before they occur.
After proper structure is in place, bring in an experienced fund accountant to set up an accounting system; this person can properly handle all the various operational and investment activities required.
Tax time gets exponentially less stressful when you call in help from the pros. Getting assistance from knowledgeable specialists allows for timely K-1 issuance to your investors, which keeps them pleased.
2. Know your firm and your investments. Fund managers must consider factors that other businessmen simply don't have to deal with, such as the proprietary valuation of companies invested in and the audits required. Understand all of this before moving forward.
While venture capital and private equity firms prefer their portfolio companies to be structured as C corporations, they normally utilize partnership structures for the "funds" they use to raise outside capital and make investments.
These limited partnership or open-ended corporate structures - sometimes called evergreen funds - are perfect for fund investors because just about all institutions are tax-exempt. So if the fund structure does incur tax, it will be negative in most cases.
3. Focus on structure. Invest in portfolios with proper structure to ensure favorable capital-gains rates. Experts urge investors to track mutual fund investments in both tax-deferred and taxable accounts because tax bills are likely to increase as annual capital-gains distributions roll in. Because it's notoriously difficult to time the market, it's more value added to choose tax-efficient funds.
4. Monitor trends. As experts say, both tax-deferred and taxable accounts need to be carefully tracked. Your tax bill is likely to increase as you receive capital-gains distributions every year, regardless of whether you withdraw the amount. Guard against this by looking for tax-efficient funds and keeping an eye on the investments you've structured with the help of your experts.
A lot of red tape, commotion, and - above all else - money surrounds investment funds. If in charge of one or many, managers must see it as their jobs to control the investment from all angles.
New fund managers don't have to be limited by unfamiliarity with investment compliance. Help shareholders align themselves with professionals who can help them structure investments and remain educated on current trends.