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Boca Raton, FL Leading Wealth Advisor —Marjorie A. Horwin Whether you choose Morrison, Brown, Argiz & Farra LLC for your business, your personal finances or both, our goal is a simple one: to work with you to design innovative planning techniques that preserve wealth, minimize taxes and maximize growth opportunities. To learn more, please contact Marjorie, Gary or Emilio at 561.909.2100. make Marjorie A. Horwin, CPA, Principal; Gary M. DuBoff, CPA, CFP®, Principal; Emilio T. Escandon, CPA, Principal How to reach Morrison, Brown, Argiz & Farra LLC grow Morrison, Brown, Argiz & Farra LLC live “Uninformed decisions may force [taxable investors] to pay hundreds of basis points in tax on phantom income.” M o rriso n, Brow n, Argiz & Farra LLC Are hedge funds a suitable investment for taxable investors? By Marjorie A. Horwin Conversely, when the hedge fund is classified as a trader, the management fees may be deducted fully in carrying on the trade or business as a nonpassive deduction under IRC Section 162, not subject to limitations. For example, if an investor hedge fund has a gross return of 12 percent and a net return of 10 percent after fees, the investor will pay tax on 12 percent. Alternatively, if a trader hedge fund has a gross return of 12 percent and a net return of 10 percent after fees, the investor will pay tax only on the net income of 10 percent. For high net worth individuals, the most taxefficient investment in a hedge fund captures returns in a form that nets expenses against income. Furthermore, if a hedge fund qualifies as a trader, it may make an election under IRC Section 475(f) to use the mark-to-market method of accounting (MTM). With MTM, the price or value of a security held open at year end is treated as if it were sold at fair market value. When trader hedge funds make the MTM election and depreciated securities reflect unrealized losses at year end, taxable losses are passed through to the taxable investor, thus generating a net operating loss. However, when appreciated securities reflect unrealized gains at year end, taxable gains will be passed through to the taxable investor. In this scenario, a taxable investor may lack sufficient funds to pay the tax liability on the unrealized gains. The reason is that the funds will not have liquidity to make distributions until the investments have been realized. It’s important to note that in the initial year of the election, the taxable gain will incorporate multiple years of unrealized appreciation, creating an even larger tax burden. The hedge fund industry’s growth is reflected in the current 10,000 individual hedge funds, with more than $2.7 trillion dollars in assets under management. High net worth individuals, or taxable investors, represent 9 percent of hedge fund investors by type and 3.6 percent of the total capital invested in hedge funds. Considering the concentration of capital that these individuals maintain in hedge funds, these investments’ performance may have a material influence on investment portfolios. The tax-inefficiency of certain hedge funds may negatively impact the after-tax returns of a portfolio, due to the factors described here. Therefore, when deciding to invest in a hedge fund, consult with your tax or investment advisor to consider the potential tax ramifications. Left to right: Marjorie A. Horwin, Gary M. DuBoff, Emilio T. Escandon About Morrison, Brown, Argiz & Farra LLC At Morrison, Brown, Argiz & Farra LLC, more than 400 highly qualified principals and employees serve domestic and international clients across a broad range of industries and practices in more than 44 countries and all 50 states from offices in Miami, New York, Baltimore, Boca Raton, Boulder, Fort Lauderdale, Orlando, Valhalla (Westchester County) and India. Providing clients with strategic guidance precisely suited to meet their needs, MBAF CPAs and advisors possess deep industry expertise spanning five specialized practice areas—tax and accounting, private client wealth, management advisory services, technology consulting and assurance—and 18 different areas of industry expertise. MBAF is ranked nationally as a Top 40 accounting and advisory firm by Accounting Today. Also named one of the 2013 Top Five Best of the Best firms in the country by INSIDE Public Accounting, MBAF was chosen for demonstrating long-term consistency and exceptional performance. Largest Client Net Worth $1 billion+ i ll u st r at i o n b y N anc y J an u z z i Hedge funds are the darlings of the investment world. Their main allure is that, when executed well, they generate returns not closely tied to global stock and bond markets, thus providing diversification to a taxable investor. However, investing in hedge funds may also lead to tax inefficiency depending upon whether the fund’s investment manager is classified as a trader or investor. Taxable investors should take care in the types of hedge funds they choose, as uninformed decisions may force them to pay hundreds of basis points in tax on phantom income. Domestic hedge funds are traditionally set up as partnerships or limited liability companies to insure that profits are taxed only at the individual level and avoid the double taxation treatment of a corporation. However, when a partnership or LLC pays high management fees to the fund manager, the result may be the investor owing more tax on income than he or she actually earns. When a hedge fund is classified as an investor, the management fees are taken as a miscellaneous itemized deduction under IRC Section 212. For taxable investors subject to the alternative minimum tax these deductions will be disallowed. Financial Services Experience Horwin, 29 years DuBoff, 35 years Escandon, 31 years Website www.mbafcpa.com Morrison, Brown, Argiz & Farra LLC Methods of Compenstation Fixed and hourly fees Professional Services Provided Tax planning and consulting, tax compliance, assurance (audit services), family office and concierge services, estate and charitable planning services Email [email protected] [email protected] [email protected] 225 Northeast Minzner Boulevard, Suite 685, Boca Raton, FL 33432 worth.com 561.909.2100 f e b r u a r y - ma r c h 2 0 1 5 085