Knowledge and Insights

Happy New Year clients and friends! February is a month during which many organizations take a hard look at their investment portfolios’ prior calendar-year performance. While the markets certainly ended strong in 2016, due, in part, to anticipated changes from the new administration, certain sectors and investment products were lacking.

We talked to Mercadien Asset Management Vice President, Jared Reilly, CFP, about the recent news and attitude changes toward hedge funds. He confirmed that there certainly has been a fair amount of press about the pressure on hedge funds and their performance, most notably from their former, biggest backers – endowments. Earlier this year, NEPC, one of the industry’s largest investment advisory firms, published a piece showing changing attitudes toward hedge funds in endowments’ and foundations’ portfolios (https://www.nepc.com/insights/some-endowments-and-foundations-reevaluating-hedge-funds-nepc-survey-finds). There’s also been a lot of press recently on the Ivy League schools’ lagging performance – with pressure on reigning in costs (high in hedge funds) and shifting (or at least strongly suggesting a change) to a more simplistic indexing approach.

Many of our nonprofit clients invest in hedge funds, partnerships and other alternative investments to increase diversification and rates of returns in their portfolios. So, our focus in this article is less on investment returns and more on the tax implications of shifting investments. In recent years, the IRS has scrutinized activities outside of the United States, including foreign investments. Many of these alternatives reside offshore. In order to properly evaluate your annual reporting requirements, you should request copies of the fund prospectus and other formation documents to determine foreign situs, and all applicable U.S. tax implications of your investments.

Generally speaking, Form 990, Schedule F, is required for organizations with foreign investments valued at $100,000 or more. However, several other forms, including Forms 926, 8621, 5471 and FinCEN 114, could also be applicable to organizations with foreign investments. Here’s information on each:

• Form 926 – Return by a U.S. Transfer of Property to a Foreign Corporation. This form is used to report certain transfers of tangible or intangible property to a foreign corporation. Exempt organizations must file this form if they contribute over $100,000 in cash or property during the year to a foreign corporation or if they own at least 10% of the voting power or total value of the corporation immediately after the transfer.
• Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. Form 8621 is required to be filed annually if a U.S. taxpayer is a shareholder of a passive foreign investment company (PFIC) and meets certain requirements. The form is used to make an election to pay taxes on the current income of the PFIC (assuming that tax is required to be paid by the U.S. shareholder). If an election is not made to pay taxes on the current income of the PFIC, then any future distributions may be subject to punitive taxes on excess distributions. Form 8621 tracks distributions and income from PFICs that otherwise may not be part of taxable income and assesses a tax with interest on those amounts (referred to as excess distributions) from the current year.
• Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations. This form is used by certain U.S. citizens and residents who are officers, directors or shareholders in certain foreign corporations in which a U.S. person (corporation) owns 10% or more of the value or voting power of the stock.
• FinCEN 114 – Report of Foreign Bank and Financial Accounts. The form, also referred to as FBAR, is used to report a financial interest in or signature authority over a foreign financial account. Any U.S. citizen that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the account exceeds $10,000, at any time during the calendar year.

Many of the investments do not have specific annual returns or forms that they must file with the IRS so U.S. investors need to ascertain the income/deductions that must be reported on their U.S. return by consulting their tax advisors. Partnership investments generate K-1 forms. The Schedule K-1 received for each foreign investment will need to be carefully examined for reporting requirements and tax compliance. Most of the K-1’s will give limited guidance about the forms that may need to be filed.

If you would like assistance with an evaluation of your investment portfolio for possible U.S. tax reporting exposures, I hope you will reach out to Mercadien for an initial consult to determine if there may be requirements you have missed. Contact us at [email protected] or 609-689-9700.