Private equity and venture capital fund activity comes with time-intensive tax reporting requirements, from managing the completion and delivery of the Schedule K-1 to tax obligations for the funds themselves.
The following questions should help you with your evaluation.
What does the process for our Schedule K-1s look like? Do we have timely delivery?
PE or VC funds organized as flow-through entities for tax purposes are required to provide investors with a Schedule K-1 package, which may include both federal and state K-1s along with possible reporting on federal and state withholding taxes. Investors need the Schedule K-1 for their own tax reporting, and there are usually stipulations within the limited partnership agreement that the PE or VC firm is to supply the Schedule K-1 to the investors by a set date.
If completion of the Schedule K-1s is running behind, the firm has a significant risk of violating its limited partnership agreement provision.
What resources are needed to complete accurate Schedule K-1s?
Aside from the logistics of delivery to investors, Schedule K-1s are cumbersome to complete. Disclosure requirements demand close collaboration with portfolio companies and their advisers. Tax-exempt investors need to know if the fund may be generating unrelated business taxable income. Recent tax reform brought new considerations for domestic investors related to the pass-through deduction under Section 199A and business interest deduction limitations under Section 163(j). Overseas investors will need to know information about whether the income generated from their PE or VC investment is considered effectively connected income or subject to U.S. withholding tax.
PE and VC funds should consider different approaches to manage the impact these complexities have on their operations, including the use of standard templates and workpapers, technology and additional staffing resources.
How is investor data being managed?
PE and VC firms must manage a significant volume of investor demographic data as part of their U.S. tax compliance. Not only must the data be efficiently and effectively managed for Schedule K-1 delivery, but it also informs other areas of investor tax compliance, including meeting U.S. federal and state withholding requirements and for compliance with the Foreign Account Tax Compliance Act and Common Reporting Standards. PE and VC firms need to have processes in place to refresh this information as needed or required by the various tax authorities and to ensure data integrity over the multiple systems that may handle investor demographic data.
Are we meeting all our tax requirements for our funds?
Overseas investors, tax-exempt investors, and desired investor and general partner dynamics can create unique holding structures with complex domestic and international tax reporting requirements. Internal tax departments … should have in place robust processes to identify the filings required and manage the workflow, often dealing with multiple service providers along the way.
Are we leveraging technology to create efficiencies?
PE and VC firms are increasingly recognizing that simply adding more staffing resources to their internal tax departments is not sufficient. Instead, they are looking for technology solutions to automate repetitive or time-consuming manual tasks or to replace their traditional workpaper schedules. Others are pushing more steps of the tax compliance process to their external service providers, which may already have sophisticated technology solutions to handle these tasks.
Claudia Mullen is a managing director in the tax group and member of the private equity and venture capital practice at CBIZ & MHM, with offices in Providence and Boston.