[quote]countingbeans wrote:
DO you follow thus far?[/quote]
As best I can…[/quote]
Well, if you don’t see the structure, my argument won’t make sense.
So we have FUND X. This is the top tier and does the actual investing in different things. FUND X is a limited partnership. The General PArtner of FUND X is FUND X GP.
FUND X GP is also a limited partnership. ABC LLC is the General Partner, and the employees of ABC LLC are the limited partners of FUND X GP. USM is a limited partner of FUND X GP.
(I’m not responsible for cpa exam flashbacks, lol)
[quote]countingbeans wrote:
When I explain this to staff in person, I can draw a picture, which helps a lot. I can’t draw pictures here…[/quote]
Lol, that’s what I’m sitting at my desk doing.
I’ll get it it’s just going to take me a few minutes.[/quote]
Okay. So back to USM.
USM get paid a salary for his job from ABC LLC correct? Yes, he does. Let’s say it si a modest salary for a NYC firm, 280k. This is taxed at ordinary rates, correct? Yes, it is.
Now, USM gets paid his salary to raise capital which he did for FUND X, and then invest that capital wisely to get returns for investors. One of the investors is FUND X GP at 1%. So until FUND X hits its “carry” FUND X GP will earn its share of income the FUND X investments generates, just like any other investor in FUND X.
[quote]countingbeans wrote:
When I explain this to staff in person, I can draw a picture, which helps a lot. I can’t draw pictures here…[/quote]
Lol, that’s what I’m sitting at my desk doing.
I’ll get it it’s just going to take me a few minutes.[/quote]
Okay. So back to USM.
USM get paid a salary for his job from ABC LLC correct? Yes, he does. Let’s say it si a modest salary for a NYC firm, 280k. This is taxed at ordinary rates, correct? Yes, it is.
Now, USM gets paid his salary to raise capital which he did for FUND X, and then invest that capital wisely to get returns for investors. One of the investors is FUND X GP at 1%. So until FUND X hits its “carry” FUND X GP will earn its share of income the FUND X investments generates, just like any other investor in FUND X.
[quote]countingbeans wrote:
When I explain this to staff in person, I can draw a picture, which helps a lot. I can’t draw pictures here…[/quote]
Lol, that’s what I’m sitting at my desk doing.
I’ll get it it’s just going to take me a few minutes.[/quote]
Okay. So back to USM.
USM get paid a salary for his job from ABC LLC correct? Yes, he does. Let’s say it si a modest salary for a NYC firm, 280k. This is taxed at ordinary rates, correct? Yes, it is.
Now, USM gets paid his salary to raise capital which he did for FUND X, and then invest that capital wisely to get returns for investors. One of the investors is FUND X GP at 1%. So until FUND X hits its “carry” FUND X GP will earn its share of income the FUND X investments generates, just like any other investor in FUND X.
Still with me?
[/quote]
So because USM is an employee of ABC, LLC and the $'s he manages are an investment ultimately through Fund X the gains on “his” investment are treated as capital gains to ABC, LLC therefore the fee he is paid on the gains should be a cap gain to him?
lol, okay so in year 5 (ignore 1 through 4 for the sake of simplicity, if I explained the flip people would be very lost.)
Year 5 works out like this:
FUND X earned through various investments:
1m in Ordinary Income
500k Interest (Net of inv int expense)
17m in Dividends
480m in Short Term Capital Gains
800m in Long Term Capital Gains
500k in Royalties (net of royalties deductions)
1m in Other Income both portfolio and ordinary (net of deductions, ignore 2% floor)
So FUND X GP therefore earned: (as 1% investor in FUND X)
So USM earned: (As 5% investor in FUND X GP)
500 Ordinary
250 Interest
8.5k Dividend
240k STCG
400k LTCG
250 Royalty
500 Other
For a total income of 650k, of which 242k is taxed at ordinary rates and 408k taxed at cap gain rates. And don’t forget his salary of 280k is taxed at ordinary rates.
[quote]countingbeans wrote:
Do you have issue with this tax treatment yet?[/quote]
For the most part no I don’t have a problem. I am starting to understand the mechanics of where his income comes from and I appreciate you breaking it down thus far.
Where I am hung up at is the fact that the original investment is not USM’s, but the committed funds & investment are from ABC, LLC. I get and agree with ABC receiving cap gains treatment on their investment so it does make sense that USM’s fee based off the cap gains should retain it’s character.
I donno, to me it just seems odd or even unfair to other tax payers that USM gets favorable tax treatment on the majority of his income (for doing his job) because the $'s his fee are based off of are really an invested by ABC, LLC and thus cap gains.
Does that make sense? I’m sure you’re right and I’ll take your word on the IRC interpretation. Perhaps my hesitation, which is really all it is, to be okay with this is philosophical.
I am following now why you originally mentioned the character of the income.
[quote]countingbeans wrote:
Do you have issue with this tax treatment yet?[/quote]
For the most part no I don’t have a problem. I am starting to understand the mechanics of where his income comes from and I appreciate you breaking it down thus far.
Where I am hung up at is the fact that the original investment is not USM’s, but the committed funds & investment are from ABC, LLC. I get and agree with ABC receiving cap gains treatment on their investment so it does make sense that USM’s fee based off the cap gains should retain it’s character.
I donno, to me it just seems odd or even unfair to other tax payers that USM gets favorable tax treatment on the majority of his income (for doing his job) because the $'s his fee are based off of are really an invested by ABC, LLC and thus cap gains.
Does that make sense? I’m sure you’re right and I’ll take your word on the IRC interpretation. Perhaps my hesitation, which is really all it is, to be okay with this is philosophical.
I am following now why you originally mentioned the character of the income. [/quote]
Well the only income he has subject to capital gains tax is based on his personal investment in the fund…his 5% of the 1%. All Partnership income gets passed on to the partners for individual income taxes. It’s not like Corporations where the corporation gets taxed as a separate entity.
And remember, ANYONE could try to make a living this way.
For the most part no I don’t have a problem.[/quote]
Okay. Well all the “carry” does is increase the share of income FUND X GP gets from 1% to some predetermined (and agreed upon with the limited partners) higher percentage, typically 10%, effectively making FUND X GP’s share 10.9% or so, because FUND X hit a performance incentive.
[quote]
Where I am hung up at is the fact that the original investment is not USM’s,[/quote]
USM’s investment is in FUND X GP, who is invested in FUND X, which USM directs through ABC LLC.
So, he earns money on his investment.
This is why I wanted to make sure you understood the tiered structure. ABC, LLC will have invested 1% in FUND X GP, which then invests 1% in FUND X. So ABC LLC is actually only investing a small portion of total committed capital. The employees of ABC LLC invest the other 99% in FIND X GP, which together only make up 1% of the investment in FUND X.
USM’s income from FUND X GP isn’t a fee, it is investment income.
No different than you investing in your 401k account. You direct what funds your 401k goes into, and your portfolio gets a chunk of the income that comes out.
It seems unfair because you are missing some key components. USM’s job goes beyond directing this one fund. Likely directs many, and is also responsible for raising capital among other general and administration fees.
He is paid a salary for doing his job, the 280k. He receives investment income when the investment makes it.
[quote]Does that make sense? I’m sure you’re right and I’ll take your word on the IRC interpretation. Perhaps my hesitation, which is really all it is, to be okay with this is philosophical.
I am following now why you originally mentioned the character of the income. [/quote]
Trust me, I can take this break down, change a couple words and argue your side too, lol.
[quote]countingbeans wrote:
Do you have issue with this tax treatment yet?[/quote]
For the most part no I don’t have a problem. I am starting to understand the mechanics of where his income comes from and I appreciate you breaking it down thus far.
Where I am hung up at is the fact that the original investment is not USM’s, but the committed funds & investment are from ABC, LLC. I get and agree with ABC receiving cap gains treatment on their investment so it does make sense that USM’s fee based off the cap gains should retain it’s character.
I donno, to me it just seems odd or even unfair to other tax payers that USM gets favorable tax treatment on the majority of his income (for doing his job) because the $'s his fee are based off of are really an invested by ABC, LLC and thus cap gains.
Does that make sense? I’m sure you’re right and I’ll take your word on the IRC interpretation. Perhaps my hesitation, which is really all it is, to be okay with this is philosophical.
I am following now why you originally mentioned the character of the income. [/quote]
Well the only income he has subject to capital gains tax is based on his personal investment in the fund…his 5% of the 1%. All Partnership income gets passed on to the partners for individual income taxes. It’s not like Corporations where the corporation gets taxed as a separate entity.
And remember, ANYONE could try to make a living this way. [/quote]
Ya, as Beans points out, I’m missing some of the key facts…
Edit: Also I understand everyone can do this. My issue is that USM is going this for a living so in my mind I’m thinking every dollar her received, based on his role with the company is salary.
[quote]countingbeans wrote:
USM works for a company, ABC LLC. ABC LLC starts an investment fund. Part of USM’s job is soliciting investors. Let’s say USM is good at his job and get a billion in committed capital. So Fund X is a billion dollar fund, USM is the primary manager of investments.
[/quote]
Okay, let’s backup. This is where I’m confused. USM was able to solicit $1B in investment dollars for ABC, LLC. He then invests through the tiered systems (I believe our example is 5% of 1%).
Here’s my confusion. That $1B isn’t his, it’s other investors money, right? The investors he was able to get to commit to ABC, LLC investment fund.
I thought hedge fund managers made their money off fees on both committed capital and gains, is that not right?
[quote]usmccds423 wrote:
USM was able to solicit $1B in investment dollars for ABC, LLC.[/quote]
Yes. Part of his job is to sell investors to allow ABC, LLC his employer to manage the investor’s funds.
These dollars are then pooled into a large fund, in our example FUND X, LP.
Yes, he invests in the general partner of the large fund.
correct
[quote]I thought hedge fund managers made their money off fees on both committed capital and gains, is that not right?
[/quote]
Where do you think ABC LLC get’s the money to pay his salary?
Yes, the people he brings in, investors pay (through the fund) ABC LLC a percentage of their committed capital as a management fee. These are picked up as ordinary income by the owners of ABC LLC.
The only income picked up as capital gain rates are the capital gains earned on the investor’s money.
[quote]countingbeans wrote:
Yes, the people he brings in, investors pay (through the fund) ABC LLC a percentage of their committed capital as a management fee. These are picked up as ordinary income by the owners of ABC LLC.
[/quote]
Okay, same page.
Right, but how is any of that USM’s? Aren’t the original investors the ones with the gains?
[quote]countingbeans wrote:
lol, just for perspective, this takes some people years to understand. I have staff who finally understand the flow in year 2 or 3. [/quote]
Oh lord…
I’ll make sure and resurrect this thread in 2021 when it finally clicks for me then.