By Robert A. Green, CPA
(Note, we invented this concept in early 2000s and have set up hundreds of incubator funds since. When we published this blog, we were not offering assurance (audit/attest) services, so we could be involved with assisting on development.)
Update on June 7, 2011:
Our outside attorney Brent Gillett takes a more conservative tack with “multi-member incubator funds”, where the owner/manager wants to admit close friends and family too, but without compensation. To better protect the owner/manager against potential claims raised by close friends and family and to give investors additional information warranted, Mr. Gillett’s law firm prefers to use investment management documents, minus the compensation clauses. He explained it to one client below.
Per Mr. Gillett, “Given that your initial investor will be passively involved in the business, you may want to consider our multi-member incubator fund structure that can accommodate investments from outside investors. We can establish this kind of investment vehicle for a flat fee of $7,500. In this case, we would essentially deliver offering documents with the same disclosures and corporate governance that would be contained in the documents for a full-fledged hedge fund but with all of the fee language removed from the documents."
The incubator fund described below should be modified for owner/manager only. We will edit and update this blog to include the “multi-member incubator fund.”
The below article will be updated soon to reflect the above change of course.
Many traders dream of having their own hedge-fund business but only a small percentage of them actually take the plunge. Why do would-be fund managers hesitate? Probably the biggest reason is start-up costs, often financed by the adviser/founder. Advisers probably can’t rely on investors to contribute toward fund expenses until after they successfully raise money and get fund operations underway, and that can take some time.
In addition to paying between $12,000 and $20,000 to form a full-fledged hedge fund, the new fund manager must plan on accounting and tax preparation for the first year of operations, running anywhere from $1,000 per month for accounting to $4,000 per year for annual income tax preparation (including investor K-1s). Both the start-up and operating costs may seem quite high, especially for a trader who doesn’t yet have investors lined up to help cover these costs.
The GreenTraderFunds incubator fund strategy and package is a great solution to this important start-up cost issue. Incubator formation costs with our attorneys in phase I are only around $3,000. Also, our CPAs perform accounting with performance record for around $1,000 per quarter, and year-end tax preparation for approximately $2,500. That's a huge savings for the adviser versus starting out with a full-fledged hedge fund.
The main value of this incubator fund strategy is to generate a historical performance record for the fund before spending the lion’s share of the expenditures for accommodating outside investors. You can scale up to a full-fledged hedge fund, or scale down to a personal trading business entity.
It’s difficult to attract outside investors without a good trading performance record, otherwise known as a track record. Institutional investors also want to see a good management and business record of success. They skip start-up managers who have not yet proven themselves as business people, and avoid fledgling managers who may not survive the next down trend.
Although a trader may have lots of experience, it is quite likely that under federal securities and futures laws, he will not be able to use quantitative measures of his success to attract potential investors in his new fund. Showing past and prior performance may be allowable under certain restrictive conditions and with using the appropriate disclaimers and disclosures. Keep in mind that prior performance may be apples and oranges compared to a new fund’s trading program too. It’s important to discuss these matters with attorneys experienced in investment management.
Our GreenTraderFunds incubator fund plan deals with these issues. We discuss prior and past performance and how it may or may not be useable. We help devise a trading program for attracting investors later on that’s both realistic and appropriate for investors. Our CPAs and accountants prepare a historical performance record for the incubator fund to be used later on in the full hedge fund documents.
Starting your hedge fund business with an incubator fund can save you over $20,000 during your first year of operations. A full-fledged hedge fund formation, with 12 months of accounting and year-end tax preparation, might cost approximately $30,000 with GreenTraderFunds (a great price). The second year’s accounting and tax will cost approximately $18,000. The GreenTraderFunds incubator fund package costs approximately $9,500 during your first year of operations, and $6,500 in the second year.
Our plan allows you to create a stellar — and marketable — performance record that conforms to all industry and accounting standards. When you are confident that investors are ready to join, you can engage GreenTraderFunds to prepare your investor offering documents and other legal paperwork, using our outside attorneys.
Choosing the wrong team can be a nightmare. Some attorneys are overworked, others sell cookie cutter documents and some can be very difficult to deal with. Attorneys may be done with you when they complete the documents, but GreenTraderFunds sticks with you for the life of your business in many areas of your operations. Some websites offer a document service, but they don’t have attorneys to review the documents, which can lead to trouble. Other sites promise a full solution, but they don’t have the experienced attorneys and CPAs. We have earned the trust of our clients since the founding of Green & Company CPAs in 1983.
Lower start-up costs
Most law firms want to sell you the blue prints and build the hedge fund all at once; they make more money that way. At GreenTraderFunds, we place our clients first and customize a flexible plan that allows you to build your fund in two separate phases. By using our incubator fund strategy, you break down the start-up process and related costs while avoiding redundancy: The two-step process usually costs no more than doing everything at once. We also design the fund with accounting and tax strategies in mind too. Some attorneys have complex terms that are hard to account for, which raises your fees.
• Phase I: Incubator. Create your hedge fund and management company (if needed) as legal entities. You begin building the fund’s performance history by trading with your own funds. This phase usually costs around $3,000. These figures are for setting up onshore funds (you pay state filing fees directly); the price for offshore entities is somewhat higher (and involves the use of offshore legal counsel).
For approximately $1,000 per quarter, GreenTraderFunds will prepare your fund accounting, which includes the performance record. We use FundCount software; your cost is a small license fee. FundCount has fantastic reports; we design the entire reporting system with you and our attorneys. We prepare your annual income tax returns for the fund and the management company. We can also prepare your individual income tax returns as well, all combined for an attractive price. Many important tax breaks from the fund and management company flow through to your individual tax return, so it’s best to use us for the entire tax preparation work.
• Phase II: Completion. Using our GreenTraderFunds outside attorneys, we prepare your offering documents, investor agreements, and other legal paperwork, and you begin accepting outside investors. For special-purpose funds and offshore funds, we also work closely with some outside law firms to provide Phase II services at excellent prices and customer service. We call the shots on tax strategies and much more, so their work fits nicely into our designs.
You can use the incubator strategy with any type of hedge fund. Whether you have a securities fund, commodities/futures fund, forex (currency) fund, onshore, offshore, master/feeder fund, or mini-master/feeder, our incubator strategy can save lots of money in your startup period.
The cost advantage of our Incubator Fund strategy is tremendous. Of course, if you already have investors lined up, you’ll want to skip the incubator phase and have the complete fund set up all at once. However, if you would prefer to move ahead in two steps, the initial cost savings are significant.
Separately managed accounts
Some of our clients prefer to start their investment management business as separately managed accounts rather than a hedge fund. We advise clients on licensing, investment adviser registrations, regulations, accounting methods, tax and business matters. We can form their management company, handle their investment adviser registrations, structure and prepare their advisory agreements, handle their investor accounting and offer tax advice to their investors. We have everything you need for separately managed accounts, with both onshore and offshore investors.
Establish a marketable track record
Unless you're well known as a successful trader in the financial services industry, with some pedigree, chances are you won't attract investors into your hedge fund until you can boast an excellent performance record. Of course, if you are thinking of starting a hedge fund, you probably have already had success trading your own accounts or trading professionally. Although prior experience in the markets is very valuable in many ways to a hedge fund manager, one thing it usually cannot provide are hard figures that can be presented to potential investors. Securities laws make it very difficult to use a manager’s prior performance figures to promote a new fund.
The problem with advertising prior performance is the fund manager must show that it is truly representative of what an investor could reasonably expect from the fund. Quite simply, the manager must demonstrate that prior apples are equivalent to present oranges. This is not easy. Trading one's own personal account or trading as part of a team at a large hedge fund are significantly different from trading in a startup hedge fund.
Creating a prior performance record is difficult and costly. Prior performance records must be audited for accuracy in accordance with GAAP (Generally Accepted Accounting Principles) and verified according to the standards established by the Chartered Financial Analyst Institute (AIMR-PPS and GIPS). The cost of hiring a specialized firm to perform verifications according to CFA Institute standards is quite high. An even greater obstacle, however, is that attorneys are very reluctant to allow the figures to be used in offering documents. Even if you pay accountants to verify that your figures conform to GAAP and AIMR-PPS / GIPS standards, most attorneys still will not include these prior performance records in offering documents because it exposes them to potential litigation from disgruntled investors.
If you have a great prior record and you plan to use the same trading program and environment in your new fund, it may well be worth the effort and cost to pursue this option. You will have to document that your prior trading strategies and working environment are very similar to your future fund trading strategy and environment. In the majority of cases, however, prior performance simply is not representative. And when it is, it is still quite possible that the potential benefits of verifying prior performance do not justify the associated trouble, expense and potential legal exposure.
Happily, the incubator fund is an attractive solution to the prior performance problem. Not only is our incubator fund economical, it generates a historical fund performance record that can be used to attract potential investors. Unlike prior performance — the manager’s investment success prior to starting the fund —historical fund performance doesn’t require verification. The historical performance record of the Incubator Fund is the record of the fund itself.
The bottom line is the majority of those wishing to start a hedge fund are better off skipping prior performance and setting up an Incubator Fund. If you want to avoid dealing with the cost, uncertainty and risk of crafting a prior performance record, you can use an incubator fund to generate the historical performance record that will appear in the fund’s offering documents. You only need a regular annual financial audit in accordance with GAAP. And even if you change the fund's trading strategy in the future, there is no requirement for verification to CFA Institute standards.
An incubator fund is flexible
Your life is easier during the incubator process. Since you don’t have investors in your incubator phase, it's much easier to prepare your accounting and NAV reports. There are no complex investor-level accounting issues. Annual tax preparation is also a snap; it's almost as easy as preparing tax returns for any trader entity. This saves you money and reduces your work and time with our professionals. Since most complications arise when investors come into the fund, an incubator fund can save you many headaches while you are getting your fund’s business operations in order.
You have time to fine-tune your business plan with an incubator fund. When your incubator fund is successful and you’re ready to meet with prospective investors, it's time to complete your hedge fund business plan and incorporate it into your offering (disclosure) documents. With the time afforded you in the two-step process, you can benefit from hindsight and experience. Maybe you want to change brokers, take soft dollars (or skip them), or change other operations like management team, systems and more. Since you can tweak your hedge fund business plan before preparing your offering documents, those documents will be more representative of your revised operations than if you created them on day one. Since these offering documents are the way you fulfill your disclosure obligations, the incubator approach provides added legal and compliance protection.
The incubator can be valuable even if you decide not to complete the hedge fund. If the incubator fund is successful and can attract outside investors, you will probably decide to move forward with a hedge fund and management company. If, however, you decide not go ahead and complete the fund, you can still take advantage of the entities created in the incubator phase, since they’re designed to accommodate business trading as well as hedge fund trading. You can use one or both of these entities to gain important tax benefits, such as retirement and health insurance deductions. Business traders often need an entity to create “earned income” in order to deduct contributions to retirement and health-insurance plans. Learn more about GreenTraderTax business entity tax strategies and retirement-plan strategies. This built-in contingency plan helps ensure that you receive the maximum value for every dollar spent with us.
The incubator fund allows you to start big or small. Many traders ask about the amount of money they should start with in their incubator fund. There is no minimum investment, though you probably will want to start with at least $25,000, which is the minimum required to establish a pattern day-trader account at a direct-access broker. To attract serious outside investors, you will want to consider trading $100,000 to $1,000,000 or more.
Incubator fund restrictions
Under federal and state laws, you’re not allowed to accept compensation in any form from investors, including yourself, during the incubation period. Nor can you accept funds from outside investors, except (in limited cases) from family and close friends. It is permissible to charge investors (and your own and related accounts) for their share of expenses, such as brokerage and bank fees or professional fees, incurred by the incubator fund while they were a member. Since you’re subject to fiduciary duty rules even with non-paying investors (which means you can be sued for losing their money), you should consult with an attorney before accepting other people's money into your incubator fund.
The bottom line
Starting your own hedge-fund business can be your ticket to financial freedom. However, it is a reality that most new businesses, including hedge funds, fail in the first year of operations. As you start your fund, plan wisely. If you decide on a low-cost, low-risk vehicle for getting your fund off to a solid start, talk to us about an incubator fund.
Learn more about our incubator fund strategies in our investment management section here and on our Feb. 15 Webinar: Investment-management business set up. February 8, 2011
Investment management update
After tense moments in the great tax debates of 2010, two important tax breaks for hedge funds and investment managers survived repeal efforts from Congress and the White House. Although Democrats tried hard to repeal “carried interest” tax breaks for investment managers, along with a related repeal of the S-Corp self-employment (SE) tax reduction breaks for professionals (including investment managers), Republicans saved the day with a successful filibuster blocking cloture on tax increases. We covered that drama on our blog and in our podcasts, click here and here.
Finally, in the year-end lame-duck session of Congress, after Republicans won majority in the House in the midterm elections, Congress agreed to extend all Bush-era tax cuts for two additional tax years (through Dec. 31, 2012), along with other important “tax extenders” too. There was no time or votes to include repeal of carried-interest and the S-Corp SE tax breaks. With a new Republican-controlled House in 2011 and 2012, it’s unlikely that carried-interest or the S-Corp SE tax break will be repealed during this session of Congress.
This translates to good news for investment advisers. Managers can continue to start up new hedge funds and structure in a “profit allocation” clause, so they receive performance income — it’s not compensation or pay — based on their profit allocation share of each income tax-category in the fund. The carried-interest tax break means the manager/partner receives a special allocation (his share) of long-term capital gains and qualifying dividends taxed at lower tax rates (currently up to 15 percent), futures gains taxed at lower 60/40 tax rates (currently up to 23 percent), and short-term capital gains taxed at ordinary income tax rates but not subject to separate SE tax rates (currently up to 15.3 percent of the base amount currently at $106,800, and 2.9 percent unlimited Medicare tax portion thereafter). That’s meaningful tax savings too. Carried-interest tax breaks can be good for investors as well.
It’s different with separately managed accounts. Although investment managers can’t use profit-allocation clauses on these accounts, they can at least use the S-Corp SE tax reduction break, which becomes even more important with incentive fees being classified as earned income (rather than profit allocation of trading gains). Managed accounts pay advisory fees which include management and incentive fees, whereas funds using profit allocation clauses only pay management fees.
In an LLC filing a partnership tax return, earned income passes through to the LLC owners subject to SE tax, unless an owner is not involved in operations (which is beyond the scope of this content).
Investment managers can only use profit allocation with investment funds and not on separately managed accounts, because only partners can share special allocations of underlying income. Special allocations are permitted and useful on fund partnership tax filings, but not with S-Corp tax returns, since special allocations reverse (taint) S-Corp elections. The IRS only allows S-Corps to have one class of stock and they insist on equal ownership treatment, meaning no special allocations are allowed.
That makes S-Corp elections a wise choice for management companies focused on reducing SE tax on underlying advisory fee earned income. Conversely, partnership tax returns are a better choice for investment funds focused on carried-interest tax breaks using special allocations, plus there is generally no underlying income subjected to SE tax anyway.
Check with us about these strategies, as there are some states such as California that have higher franchise taxes on S-Corps, but usually materially less than the possible SE tax savings. New York City taxes S-Corps like C-Corps and those tax rates are high.
An existing LLC or C-Corp can file an S-Corp election (Form 2553) by March 15th of the current tax year. The IRS automatically grants late relief under a special Revenue Procedure, up until the due date of the tax return including extensions. Check with us about your home state too.
This article is just a recap on the recent saga of two important tax breaks for investment managers. There are plenty of other important matters to consider too, including trader tax status and Section 475 MTM accounting, lower 60/40 Section 1256g forex tax treatment breaks, international tax planning including PFIC and QEF elections, mini-master feeders, good offshore fund destinations, other tax and regulation changes and more. January 29, 2011
Spot forex update
By Robert Green CPA and Mark Feldman JD
It’s not clear if spot forex traders can elect out of Section 988 (ordinary gain or loss treatment) with a capital gains election into the lower 60/40 tax rates of Section 1256(g). Interbank (forex) forwards are allowed, but spot forex isn’t specifically mentioned and the IRS has been reluctant to expand the definition.
If you have significant trading gains on spot forex contracts, the Section 1256 tax rates (such as foreign currency forwards) — which are up to 12 percent lower than the ordinary tax rates currently — may be very material and desirable to you, your forex fund and/or managed account investors. Forex transactions are reported in summary form. It’s not clear in the tax code when you should use cash vs. MTM treatment. If using Section 1256(g), MTM treatment is required.
We will discuss these issues in our upcoming Forex Tax Webinar scheduled for March 1. A recording is available.
We will also discuss the fact that forex brokers generally don’t report rollovers as realized transactions. Most forex brokers treat rollover interest as part of forex trading gains and losses and we make a case for how brokers are correct in not treating it as interest income.
Another forex tax update
We last discussed forex tax treatment in our Forex Tax Update blog. Here’s an important update on further developments.
We’re having ongoing discussions about retail forex tax treatment, specifically spot forex, with IRS officials in charge of writing Section 1256 regulations (the lower 60/40 tax rates on futures). We’re also speaking with a wide spectrum of players in the industry to understand the various types of retail forex trading which exist. This process will culminate in a face-to-face meeting with the IRS officials. We hope to convince the IRS to provide formal written guidance stating that retail forex qualifies for Section 1256; failing that, we will seek informal guidance from the IRS. This process may take some time, but in the meantime, we will get a better sense of what the IRS is thinking, and this will help us advise our clients properly even before the IRS makes a decision.
We believe there is at least “substantial authority” for the view that retail forex qualifies for Section 1256(g) 60/40 treatment. However, you should realize that not all of what is commonly called “retail forex” or “spot forex” necessarily qualifies. For example, it’s necessary for the forex to be traded on the “interbank market,” and we need to determine that the particular forex platform that you use qualifies. It is therefore important that you speak with us so that we can determine whether your situation falls within 1256(g).
Is retail spot forex a true Interbank transaction?
Many retail forex brokers use a software trading platform like MetaTrader. In our phone discussions with IRS officials, we sensed friction in their view of retail trades executed on some retail software platforms, challenging if those trades are true transactions in the Interbank forex market.
One leading forex brokerage firm explained that they transact in large block trades for spot forex with a major bank in the Interbank market — we call that a wholesale trade — and the retail forex broker then breaks up those block trades into pieces, redistributing them to their retail customers. As we explained to the IRS, these are retail trades in the Interbank market that go through a wholesale/retail distribution model, just like in other industries.
We’ve heard that other forex brokers have less direct connection with the Interbank market and in a sense make their own market with retail customers, with the firm taking the other side of trades with their customers. Some of these brokers may net their book of long and shorts on given currencies and then cover their risk in the direct Interbank market. The IRS may seek to deny Section 1256(g) with these brokers claiming the trades don’t meet the requirement of being in the Interbank market. Remember, retail spot forex is “off-exchange.” We need more interaction with forex industry players to fine-tune our arguments here, so contact us to discuss it.
The NFA recently published enforcement actions and fines against retail forex brokers Gain Capital and IKON, citing among other issues “slippage” in prices from using their software platforms. Read those actions to learn more about how regulators view the retail forex marketplace using software trading platforms.
Section 1256(g) requirements are specific
Forex brokers are offering retail transactions based on wholesale transactions and price references in the Interbank market. The IRS may argue that if a retail broker makes a “house market” in offsetting trades with retail customers and doesn’t transact significantly in the Interbank market, their trades aren’t true Interbank trades.
In 1986, the IRS added Section 1256(g) foreign currency contracts to Section 1256 and specifically only included “forward contracts.” Electronic trading in spot forex wasn’t possible in 1986, it only became prevalent after 2000.
There are three IRS requirements for inclusion in Section 1256(g):
1. The forward forex contract is traded in the Interbank market
2. The forex contract can be marked.
3. The delivery is based on the value of the foreign currency.
This last point was the reason forex OTC options were bounced out of Section 1256(g) in Revenue Ruling 2007-71.
In a variety of financial instruments, plenty of financial institutions and players act as market makers, and transactions are routed in all sorts of different ways. In our view, it’s unfair for the IRS to assert that retail forex in any form is not a true Interbank transaction. It’s designed, packaged and sold that way and clients and regulators hold brokers accountable for pricing that matches prices in the Interbank market. If it walks and quacks like a duck, it’s a duck.
Will the IRS assert that spot forex is a physical currency?
Before spot forex can enter coveted Section 1256(g), it first must get a ticket out of Section 988, ordinary gain or loss rules. The IRS will only allow a foreign currency transaction to opt-out of Section 988 if it’s a forex contract for future delivery like forwards. Spot settles in 24 or 48 hours and clients trade it electronically, starting with a spot trade and either exiting or rolling over the position before it settles in 24 or 48 hours.
The IRS expressed some difficulty getting its hands around the idea that spot isn’t a physical currency; when Section 988 was drafted that’s what they had in mind. Spot forex was the bulwark of global corporations to exchange currency. Traders may opt out of Section 988 into capital gain or loss, but only on forex contracts for futures delivery. Does that include spot forex? Yes, it may, according to IRS guidance, if the trader doesn’t take delivery of the currency but exits the position before it settles in 24 or 48 hours.
Spot forex is like a short-term forward
We think the IRS will agree that spot forex is like a short-term forward contract for future delivery. An electronic trader doesn’t buy a currency to take delivery of it. In fact, they aren’t permitted (or qualified with credit) to take delivery. The industry practice is to force exits of those positions before settlement or the transactions are rolled over automatically by the broker, with the current price and margin adjustment necessary to stay in that position.
The CFTC commissioner argued to Congress that spot forex is futures-like — making a similar point about spot being a short-term forward.
One leading broker told us his clients didn’t even realize spot trades had to be exited in 48 hours — they figured all trades would be rolled over by the broker automatically, which is generally the case. Brokers don’t treat spot forex rollovers as realized (closed) transactions; they defer the gain or loss to the final sale of the contract, only making price and margin adjustments with each rollover.
Here’s what we’re facing with our current IRS discussions on spot forex tax treatment: Spot forex is truly a short-term forward so traders may opt-out of Section 988 with the capital gains election. That part may not be a big deal to the IRS, since it may prefer that clients be subject to net capital-loss limitations ($3,000 for individuals) than remain in default Section 988 with unlimited ordinary-loss treatment.
It’s going to be difficult to get the IRS to formally agree on opening the coveted door to lower 60/40 tax rates in section 1256(g). Leaving Section 988 means spot isn’t a physical currency and it’s like a short-term forward forex contract. If we can show the retail trade is in the Interbank market, we should meet that first of three requirements for Section 1256(g). In our view, spot forex meets the second requirement that it can be marked, and third requirement that delivery is based on the value of the foreign currency.
Will a “substantial authority” opinion letter help?
Another point to consider is whether or not to get a “substantial authority” opinion letter, otherwise known as a tax opinion letter from a firm like our Green & Company CPAs, LLC.
If you take the position that retail forex qualifies for 1256(g), and the court rules against you, you would be subject to a 20 percent substantial understatement penalty (plus interest on that penalty calculated from the date the tax return was due, plus any extensions) unless you prove there was “substantial authority” for your position. This penalty would be based on the amount of your tax underpayment attributed to this posture taken on retail forex.
The substantial authority standard is less stringent than a “more likely than not” standard (a greater than 50 percent likelihood of being upheld in litigation). A taxpayer doesn’t have substantial authority for a position if it’s “fairly unlikely to prevail in court upon a complete review of the facts and authorities.” The regulations state the weight of authority supporting the treatment of an item must be substantial “in relation to the weight of authorities supporting contrary positions.”
Tax return disclosure
There’s an alternative to getting a substantial authority opinion. You could disclose on your income tax return that it’s based on your belief that retail forex qualifies for 1256(g), and the IRS isn’t allowed to assess the 20 percent substantial understatement penalty. Some taxpayers think tax return disclosure in this manner is undesirable because they may be flagging the item for the IRS, and it may increase the chances of an exam. Therefore, it is important for you to hire a firm like our own experienced in how and when to provide this disclosure.
Rollover trades and rollover interest
Each day or two the spot trade ends and traders must sell or rollover the trade; they can't take delivery of the currency itself. So long as the trader has not finally terminated his position in the currency, some forex platforms do not report a gain or loss on the exchange rate appreciation or depreciation.
There can be large movements in the exchange rate and a large unrealized gain or loss deferred through year-end. These forex platforms provide a year-end statement which doesn’t report the unrealized (in their view) exchange rate gain or loss; they only report the interest-rate spread changes daily — otherwise referred to as “rollover interest.”
When electing into 1256g, MTM is required and no deferral is allowed at year-end on open rollover positions, including both interest and currency appreciation /deprecation. Traders need to get this missing MTM information from their brokers to report the correct realized and unrealized gain/loss to the IRS at year-end.
Our tax preparers aren’t going to be happy with some of these situations, especially when a client stays in Section 988 and doesn’t use MTM reporting.
On one side of a rollover transaction, the rollover interest is being summarized by many forex brokers on their year-end reports — purportedly useable for tax reporting —and on the other side, the deferred rollover price appreciation or depreciation is not being reported on year-end reports. Depending on the type of carry trade” that a trader makes, this inconsistent tax reporting treatment may help or hurt them. We are working more on this area and expect an update on it from us soon.
Until the IRS publishes specific guidance on modern spot forex trading tax treatment, there are plenty of grounds for differing interpretations and tax return postures. We believe our arguments support “substantial authority” tax return positions and that tax return disclosure is probably a good idea if you do it in the right manner. Our CPAs and tax attorneys can help, so contact us soon.
Note about our tax opinion service
We offer our tax opinion service to new clients too. You don't have to be a current tax preparation client to use our service. New clients should start with a 30 or 60 minute consultation with our tax attorney Mark Feldman to discuss their situation and to see if a tax opinion on forex tax treatment is appropriate. June 18, 2010
Is the tax extenders bill passable?
The tax extenders bill is struggling and the Senate voted 56-40 Thursday night to close debate on the bill. Some pundits argue this type of vote is a final “no.” But Sen. Harry Reid (D-Nev.) is trying to pass a revision of this bill by the July 4th recess.
Sen. Max Baucus (D-Mont.), chairman of the presiding Senate Committee on Finance, says, “The bottom line is, we're going to keep trying (on this bill).”
The latest round of voting included several important amendment modifications. (See the text of the last modified bill and a summary on the Senate Committee on Finance Web site.) The latest amendment took back some of the split between ordinary and carried interest — not good news for investment managers. The Senate removed the two-year phase-in period (with a 50/50 split), and the original 75/25 ordinary/carried-interest split in 2011 is back on the table after being lessened to 65/35 last week. (Perhaps this is to help lessen the harsh impact of a wider repeal of the S-Corp SE tax loophole.) The Senators listened to venture capitalists and shortened their holding period to five years (rather than seven) for the 50/50 ordinary/carried split.
The Senate also narrowed the S-corp SE tax repeal in its last modification; S-corps that have a material amount and number of non-owner professionals would be exempt from SE tax. I argue it’s unfair to charge an SE tax on the “return on human capital” element in S-corps, when owners have a material number of non-owner workers. This last modification says “only if 80 percent or more of the professional service income of the S-corporation is attributable to the services of three or fewer owners of the corporation.”
The good news is this bill is failing. Drama and brinksmanship continue in the Senate over trying to pass it. This fight seems to be the new battle line for the upcoming midterm elections, with campaigns well under way. Growing heat from the Tea Party over excessive spending and deficits is making it very difficult for Democrats to enact more Keynesian spending, including extending unemployment benefits and helping states, teachers, police and firefighters. Republicans also generally cry foul when Congress tries to raise taxes on job creators, especially during a jobless recovery and potential double-dip recession.
After harried attempts to make changes, which some liken to putting lipstick on a pig, Chairman Baucus seems to be throwing in the towel. But Leader Reid won’t have it; he vows further revision and voting before the July recess. Will this bill be out after three strikes?
Senator Olympia Snowe (R-Me.) — an important moderate who is courted by Democrats for key votes — was particularly interested in reducing the S-corp SE tax impact on small-business job creators. The Senator voted for closure along with all other Republicans and a few key Democrats.
It may be more prudent going into the midterm elections for the Senate to follow the successful lead of the “doc fix” arranged on Thursday. That vote succeeded because Senators on a bi-partisan basis narrowed the length and amount of this spending allotment and found savings and revenues, besides tax increases, to pay for this targeted bill. Maybe we have a new winning formula here.
Click here for more media coverage: WSJ, The Hill, Reuters, New York Times, and Courthouse News.
The Hill article on Saturday, June 19 explains the politics of this bill. The author doesn't agree with Leader Reid who blames Republicans again for failure to pass the bill, and not caring about the unemployed.
Key Democrats like Nelson (D-Neb.) and Lieberman (I-Conn.) also voted no both times on this bill, insisting it be fully paid for without adding to the deficit. They may like some Republicans' suggestions (Thune amendment elements) to use available stimulus funds rather than new deficit spending, but they don’t want to go as far as the Republicans in entirely dropping tax increases from the bill too.
Perhaps round three of this bill will include stimulus funds, reduce spending and still keep in the tax increases. That may win back the “say-no-to-deficit-spending” Democrats, but is it enough to also win over the "gettable" Republicans Snowe and Collins? Both groups are needed to gain 60 votes for passage.
Many economists, the Chairman of the Federal Reserve and the Secretary of Treasury are advocating more Keynesian spending and not withdrawing stimulus too early. What's anyone’s logic for not using available stimulus funds now, and in this bill? Perhaps some elements of this bill don't qualify for stimulus spending. Last year, Republicans and blue-dog Democrats were upset that TARP and other stimulus bills were not being used as intended. If those stimulus funds are adequate for pared-down stimulus needs in this bill, why also raise taxes now on small-business job creators? Stimulus only makes sense if it spurs growth and tax increases generally hurt growth.