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In today's ever-changing asset management environment, staying ahead of key trends can be daunting.

To make it easy for fund managers like you, Baker Tilly hosted our annual year end asset management webinar and provided insights on environmental, social and governance (ESG), tax updates and cybersecurity. Our practitioners provided reviews, updates and key topics to stay aware of as you navigate your business into 2024. 

For more information about any of these topics contact our practitioners or watch our full webinar at the bottom of this article. 

Tax updates:

IRC Section 1061, introduced by the Tax Cuts and Jobs Act (TCJA) in 2017, recharacterized certain net long-term capital gains as short-term capital gains for partners holding applicable partnership interests (APIs). This provision affects the tax treatment of carried interests in hedge funds, private equity, and other investment partnerships.

  • Exemption from 3-year holding with strict substantiation
  • Partnership agreements may need to be updated in 2024
  • K-1 white paper detail reflecting carry and capital allocations should be tracked separately
  • The IRS has explicitly stated that if long-term gains aren’t specifically reported with this split, all long-term gains will be treated as short-term gains
  • Alabama is phasing out Business Privilege Tax (BPT) cutting it down from $100 to $50. By 2024, this tax will be completely gone. 
  • New York the business capital tax, which was originally set to phase out at the end of 2023, will now be phased out on Jan. 1, 2027 instead. 
  • North Carolina is making some changes to the net worth base and investments held by limited partnerships versus limited liability companies. They’re adding a $1 million backout to the net worth base, and this will start from Jan 1, 2025. 
  • Oklahoma repealed the corporate franchise tax; this will be effective for the 2024 franchise tax year. 
  • Tennessee they’re introducing a $500,000 franchise tax exclusion for the tax year 2024. Also, they’re moving to a single sales factor, which will be fully effective for tax years ending on or after December 31, 2025. 
  • Texas is increasing the no tax due threshold to $2.47M for reports due in 2024, up from $1.23M in 2023. 

In response to this limitation of the Tax Cuts and Jobs Act, many states have enacted laws allowing pass-through entities (PTEs), such as partnerships and S corporations, to elect to pay SALT at the entity level. 

Proposed updates to partnership agreements: 

  • Need for special allocation provisions: Special allocation provisions are crucial in partnership agreements as they provide a framework for distributing profits and losses among partners. They allow for flexibility and can be tailored to the specific needs of the partnership. 
  • Designation of election: It’s important to designate who makes the election and whether they can choose not to make the election ensuring clarity and avoiding potential disputes. 
  • Implementation of special allocation: The partnership agreement should include a provision that reduces cash entitlement correspondingly when a special allocation is implemented. 
  • Designation of special allocation determinations: The agreement should clearly designate who makes special allocation determinations, which will help in maintaining transparency and accountability. 
  • Definition of tax: The agreement should define the tax — PTET subject to special allocation versus PTET not subject to special allocation. 
  • Estimates and reduction of current year draw accounts: Helps in managing the cash flow of the partnership. 
  • True up reduction in cash following year end: Allows the partners’ capital accounts to be accurately reflected. 
  • Recoupment with respect to withdrawing partner: Protects the interests of the remaining partners. 
  • Adjustments to guaranteed payment partners: Ensures that the partners are compensated fairly for their contributions. 

During 2023, the IRS trained over 100 individuals on technical aspects of subchapter K, and they plan on using an Artificial Intelligence (AI) tool to look at returns and issue notices starting with large partnerships. Notices will begin being sent starting in Oct.  

The IRS has key focuses on their areas of enforcement including:  

  • Sales and other dispositions of partnership interests 
  • Distribution in excess of partner’s basis 
  • Partnership losses in excess of partner’s basis 
  • Self-Employment Contributions Act (SECA) tax: Whether limited partners and members of LLCs and LLPs should be subject to self-employment tax 
  • High-income non-filers – this will be determined by tracing Schedules K-1s and other information returns. 
  • Offshore Lending as a US Trade or Business (Financial services entities engaged in a U.S. trade or business). 
  • Transfer pricing adjustments on related party loans and other controlled transactions (IRC 482). 
  • Reconciliation of beginning to prior year ending balance sheet balances 

Last week, the tax court made a significant ruling in the case of Soroban Capital Partners, L.P. v. Commissioner. The court ruled that limited partners in the hedge fund could be subject to self-employment tax on their distributive share of partnership net income if they are actively involved. 

  • Background The Self Employment Contributions Act (SECA) defines “self-employment income” as net earnings from self-employment. However, Section 1402(a)(13) excludes the distributive share of any item of income or loss of a limited partner. The Soroban limited partnership filed a motion for summary judgment, arguing that its limited partners’ distributive shares should be excluded from self-employment income. 
  • IRS argument The IRS disagreed with Soroban’s argument, stating that a functional analysis was necessary to determine whether the limited partner was an “active” limited partner that would not benefit from the exception. 
  • Tax court ruling After analyzing the legislative history of Section 1402(a)(13) exception, the controversial 1997 proposed Treasury Regulations, and previous tax court cases. The court concluded that the exception does not apply to a partner “who is limited in name only” and who is not actually functioning as a passive investor. 
  • Implications The Soroban ruling follows several cases in which the IRS has successfully challenged the application of the limited partner exception by active owners of various types of passthrough entities. However, this is the first time a court has ruled on whether an active limited partner of a state-law limited partnership can claim the limited partner exception. 
  • Conclusion The Soroban ruling has significant implications for limited partners who are actively involved in their partnerships. It underscores the importance of understanding the roles and activities of limited partners in determining their tax obligations 
Environmental, social and governance (ESG) tax credits

While social responsibility underscores transparency in reporting, stakeholders are demanding optimized operational structures that manage the global tax rate, meets demands of mobile workforce, maximize federal and state tax incentives and remains attractive to investors. It's important to architect a complaint tax solution that is sustainable, transparent and adaptable.  

ESG emerged due to historical practices and the current social trend of expecting greater sustainability – including sustainability in tax. This includes: 

  • Tax transparency of businesses 
  • Their tax impacts 
  • Use of tax credits 
  • Total taxes paid 

The Inflation Reduction Act (IRA) enabled developers of renewable energy facilities to sell the investment and production tax credits (ITC & PTC) generated by their projects to an unaffiliated purchaser to offset their federal tax liability. IRA 2022 provides for a direct offset to tax liability in the form of a tax credit enabling all entities to utilize this legislation regardless of tax status.

  • Purchased at a discount to provide a return, ITC and PTC may be:
  • Carried back for up to 3-years and for a refund from the government
  • Applied the credit to their current tax liability, including quarterly installments
  • Carried forward for up to 22-years

The purchase of ITC and/or PTC is also a pathway to accomplish corporate ESG goals related to renewable energy. Under IRC §50, ITC will be recaptured if the asset ceases to be eligible ITC property (e.g., if sold, disposed, or otherwise ceases to operate) within five tax years from the point where the asset is placed in service. The amount of recapture phases down by 20% annually.

NMTCs were enacted with the Community Renewal Tax Relief Act of 2000 and since then over $80B of NMTC since inception without a known event of recapture. NMTCs stimulates commercial investment in low-income census tracts. It works by investors purchasing the stream of credits at a discount where their total return is in the form of the tax credits.

Financial reporting of NMTC:

  • Rather than consolidating under VIE rules, NMTC investors typically report using the Proportional Amortization method, which FASB made available to NMTC investors as of 2023.
  • Proportional Amortization allows for timely and accurate presentation of the NMTC investment’s overall impact on the investor’s financial position.
Cybersecurity

Align with a cybersecurity framework and conduct an assessment against it (e.g., NIST Cybersecurity)

Implement cybersecurity program that outlines:

Cybersecurity governance

People: roles and responsibilities, subject matter expertise, employee training and social engineering testing

Process: policies and procedures, internal controls,

Technology: intrusion detection system (IDS), intrusion prevention systems (IPS), firewalls, ongoing monitoring, data loss prevention (DLP)

  • Policies and procedures: implement rules before you add cybersecurity systems  
  • Risk assessment: align resource allocation, spending the right time and money into the right place  
  • Third party vendor oversight: review your vendors and their cybersecurity programs to determine alignment with your requirements  
  • Access control: user access provisioning and review, privileged access control  
  • Toolsets: IPS/IDS, Firewalls, DLP, monitoring tools  
  • Employee training on security awareness, phishing and tabletop exercises (disaster recovery, business continuity, incident response, crisis management) 

Stay ahead of key trends in 2024, for additional information or further discussion on any of these topics, please connect with our asset management professionals.

John Basile
Partner
Mark Herzinger
Principal
Les Kulin
Principal
Lori Catapano
Partner
Russell Sommers
Partner
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