CFO 2.0: Navigating the tax maze

Staying abreast of new tax rules and recommendations can be a daunting task for CFOs. That information overload has forced them to rely more heavily on external tax advisors, according to Michael Laveman, an EisnerAmper tax partner and co-chair of its New York tax practice.

Michael Laveman

According to the 2017 pfm/EisnerAmper CFO Survey, 82 percent of respondents say they have increased their reliance on outsourcing tax issues in the past year, up from 76 percent in the 2016 survey. What do you attribute that to?

There’s so much complexity – and it increases constantly. You need to be a specialist in many areas and have global expertise. Clients don’t want to necessarily do all of the work themselves; however, they want to understand it to some degree. These clients still want to be involved, but they don’t have the time or resources to drill completely down on tax issues.

You can outsource to a third-party administrator that has a tax department, or you can engage a business advisory firm, such as EisnerAmper, to do some or all of the work. For FATCA (Foreign Account Tax Compliance Act) compliance and Common Reporting Standards, it’s usually prudent to outsource. We have clients that don’t want to review all of the tax reporting forms, so they engage us. Outsourcing is much more project-based, so it can be different from year to year.

Why has tax become so important to the CFO function?
The biggest trend we see today in investment structuring is AIV structures. Five or 10 years ago, if a firm had one fund and eight to 10 investments, today they’re creating separate vehicles to account for their different investments. It’s common to invest in LLCs and other pass-through entities.

This can present a variety of federal, state, local and international tax issues. Non-US investors are sensitive to effectively connected income (ECI), while tax-exempt investors are sensitive to unrelated business taxable income (UBTI). You have to create entities to accommodate these disparate investors. Decisions need to be made on how complex a fund structure should be from a cost perspective, while balancing the needs of different investor bases. For these entities you have international, state and federal issues. We have added many resources over the past several years to assist clients on both consulting and compliance on these structures.

Investors are also much more tax savvy and focused now. Many due diligence questionnaires that come to CFOs are 20 to 30 pages long. They used to ask limited tax questions. These CFOs now want to understand what tax positions the fund is taking. The K1 tax reporting forms may not contain sufficient information. These due diligence questionnaires fill in the blanks, and we help our clients to complete the forms.

What new rules are top of mind for CFOs?
Fee waivers, by far. The IRS has proposed regulations to restrict arrangements whereby private equity funds waive their management fee to obtain future profit allocation. Instead of being taxed as ordinary income at the management company level, the fees are taxed at the more advantageous long-term capital gain rate several years later as investments are sold within the fund.

FATCA: Often outsourced to external advisors
Fee waiver rights: Increasingly under IRS scrutiny
Partnership audit rules: New rules mean that tax will be assessed at the fund level as of January 1, 2018
Due diligence questionnaires: Can be as long as 20-30 pages
AIV structures: Contain a host of international, state and federal issues

The IRS introduced this proposed regulation about 18 months ago. And while it’s not finalized yet, people are spending significant time discussing it. Most new funds we see are incorporating language to address that. However, its legacy funds are more challenging.

How are CFOs addressing the IRS’s new partnership audit rule?
The IRS has changed the way funds will be audited effective for tax years beginning January 1, 2018. While the IRS has an effective date, it has yet to finalize all of the rules. Notably, there are unknown rules as to multi-tier partnership structures, which are common in the private equity world. Most of our clients are still reluctant to make changes to the partnership agreements until they see the final rules.

Regarding 2018 tax year audits – which probably won’t happen until 2020 at the earliest – any adjustments resulting from errors found by auditors will be made at the fund level. Previously, if auditors found a mistake in a fund audit, those adjustments would be directed to the fund investors and they would have to change their returns. Administratively, it was very difficult for the IRS to assess the tax on a fund with multiple tiers. As such, they established the rules to assess the tax at the partnership level.

This is significant because if you have an audit for the 2018 tax year and you are a partner in the partnership and sell your interest, the new partner would pay the tax. This becomes a sensitive issue for LPs.

How has this added tax complexity changed your relationship with CFOs?
Previously, we saw clients at the end of the year, perform some planning, and review companies they bought and sold. Now, we see clients two to four times a year. We review all of the companies they bought and sold, discuss the hot-button issues, and determine how to build efficiencies into the tax process

Over the past few years, many of our clients have hired internal tax positions. Even mid-tier funds are starting to staff internally for tax issues. Many of our meetings these days contain both a tax director and the CFO/controller.

Michael Laveman is a tax partner and co-chair of EisnerAmper’s New York tax practice. He specializes in complex tax advisory and planning services for the financial services sector, including both start-ups and well-established clients such as hedge funds, private equity funds, venture capital funds and funds of funds

This article is sponsored by EisnerAmper and appeared in the supplement CFO 2.0: The New Frontier published with Private Funds Management in November 2017.