Venture capital and private equity firms have a host of new tax developments to keep in mind as fall gets underway. While it may be tempting to stay focused on building your portfolio and growing the companies within it, those who keep the wider regulatory climate in mind will fare better in the long run.
Developments from the IRS and the courts brought both opportunities and concerns to the venture capital and private equity investment world during the third quarter. To help you stay current, we’ve prepared a briefing of those likely to impact the venture capital and private equity industry going forward.
FATCA Challenge Dismissed
Some taxpayers are concerned about the compliance complexity imposed by the Foreign Account Tax Compliance Act (FATCA). Unfortunately, it’s here to stay for now. A district court dismissed the amended complaint of a US citizen living in Saudi Arabia who challenged the act’s constitutionality in Alsheikh v. Lew, for example. The court found the amended complaint, like the original, failed to establish that the taxpayer had standing to bring the suit because it didn't sufficiently allege he was injured by FATCA, or that the FATCA-related harms he experienced were imminent.
Deadline Approaching for FATCA Agreement Implementation
The US Treasury will begin updating its Intergovernmental Agreement (IGA) List—the list of jurisdictions treated as if they have an IGA in effect—on January 1. As a result, certain jurisdictions that haven’t implemented their IGA agreements won’t be treated as if they have an IGA in effect any longer.
This change may bring consequences for foreign financial institutions in these jurisdictions. Under FATCA, these institutions won’t be able to rely on the IGA to be treated as complying with, and exempt from, withholding. They’ll generally have to enter into foreign financial institutions agreements in order to comply with their FATCA obligations, including reporting information to the IRS and withholding according to the terms of the agreement.
IRS Examines Tax Treatment of Crowdfunding
Generally, money received from crowdfunding without an offsetting liability—such as a repayment obligation—may be included as income, according to an information letter released by the IRS. The rule pertains, subject to facts and circumstances, as long as the money received isn’t a gift or a capital contribution to an entity in exchange for a capital interest in the entity. Crowdfunding revenue must generally be included in income when it’s received for services rendered or is a gain from the sale of property.
Offshore Voluntary Disclosure Program
The IRS’s Offshore Voluntary Disclosure Program (OVDP) helps taxpayers with undisclosed offshore assets become current with their tax liabilities. Using this program may help you comply without fear of being penalized for not already being in compliance. Out of a random sample of 100 taxpayers who submitted requests to the OVDP, 29 were potentially subject to reports of Foreign Bank and Financial Accounts (FBAR) penalties, according to a Treasury Inspector General for Tax Administration (TIGTA) audit released in June. Yet the IRS didn’t initiate any compliance actions in these cases, nor did it assess approximately $21.6 million in delinquent FBAR penalties, according to the audit.
“In an increasingly global economy, it’s important that the IRS ensures taxpayers with foreign-derived income comply with their US tax obligations,” said J. Russell George, the inspector general.
IRS Allows Alternative Basis Recovery Method
The IRS has allowed an alternative basis recovery method for a shareholder’s contingent installment payment sale in four nearly identical private ruling requests. It did so because the original method, combined with a drop in the acquiring corporation’s stock price, would substantially and inappropriately defer recovery of their basis.
This is good news for venture capital and private equity firms. Taxpayers can now use the alternative basis recovery method if they can show that the use of the normal basis recovery rule described in the regulations for contingent payment sales would substantially and inappropriately defer basis recovery. Yet the alternative basis recovery method is costly and time consuming because a ruling must be obtained from the IRS before using it. The taxpayer also must file a ruling request—including extensions—before the due date for the return.
Debt Versus Equity Final and Temporary Regulations
According to the IRS, the final and temporary regulations issued on October 14 narrowly target the transactions of greatest concern while still being administrable. These regulations substantially revised the prior proposed regulations to minimize the burdens imposed on taxpayers in response to the comments received. We expect more details to come next quarter.
PATH Act Brings More Tax-Free Gain Potential
The Protecting Americans from Tax Hikes Act of 2015, known as the PATH Act, retroactively restored the qualified small business stock provisions for stock acquired in 2015 and thereafter. With the provisions of Section 1202 in place, venture capital funds can potentially turn a big payoff from a successful early-stage investment into tax-free gain.
The Patriotic Millionaires' Lobbying Effort
A group of wealthy individuals, the Patriotic Millionaires, unveiled a lobbying effort to increase the amount private equity managers pay in taxes on their carry from about 20 percent to about 40 percent. The group is targeting influential lawmakers, so it’s important to monitor development on this issue.
Leniency on Failure-to-File Penalty
The courts may be willing to overlook partnerships that fail to file tax return information if those partnerships made reasonable efforts to attain the information. In the bankruptcy case Refco Public Commodity Pool, the court ruled that a partnership that didn’t file returns for three years wasn’t liable for a failure-to-file penalty because most of its income and other tax return information was from its investment in another partnership that didn’t provide it with Schedule K-1s for those years. Despite reasonable efforts, the partnership was unable to obtain that tax information from other sources.
IRS Sets Out Potential Employer Mandate Penalty
An employee who works an average of 30 or more hours of service per week during any given month could potentially trigger—or increase the amount of—employer liability for an assessable payment. The amount of the employer’s potential health coverage liability under Section 4980H(a) is based on the number of employees who average 30 or more hours of service per week in a given month, according to an IRS information letter.
We're Here to Help
Contact your local Moss Adams venture capital and private equity team if you’d like to learn more about reducing risk, using the OVDP program, or gaining tax savings from the PATH Act.