Hedge Fund Schedule K-1s and U.S. Foreign Reporting

Hedge funds are investment partnerships that issue a Schedule K-1 to investors which are partners in the partnership. The Schedule K-1 reports the partner’s distributive share of the taxable income, gain, loss, deduction and credit from the partnership. The Schedule K-1 is filed with the hedge fund’s U.S. federal partnership tax return. Hedge funds issue Schedule K-1s with detailed footnotes which include disclosures regarding additional reporting that may be required by the partners on their respective U.S. federal tax returns. Hedge fund Schedule K-1s typically include certain foreign reporting disclosures regarding the fund’s investments in foreign corporations including Passive Foreign Investment Companies (PFIC) and foreign partnerships.

Some of the U.S. foreign reporting disclosures that typically appear in hedge fund Schedule K-1s including the following.

1. Form 926 reporting for transfers to foreign corporations. A hedge fund’s Schedule K-1 footnote disclosure will provide the partner with information regarding the partner’s share of the hedge fund’s capital contributions to a foreign corporation. If the partner’s share of the capital contribution is $100,000 USD or greater taking into account all transfers during the 12 months preceding the date of transfer then the partner is within the Form 926 filing threshold. Depending on the partner’s ownership percentage in the hedge fund, if the partner is considered to own indirectly 10% or more of the foreign corporation after the hedge fund’s capital contribution, then the partner is within the Form 926 filing threshold.
2. Form 5471 reporting for ownership interests in foreign corporations. Typically hedge funds acquire smaller percentages of ownership in foreign corporations. A partner in a hedge fund that invests in a foreign corporation may not be considered to acquire a 10% indirect interest so they may not be within the Form 5471 filing threshold. However, if the fund invests in a foreign insurance company then any percentage ownership in the foreign corporation would trigger a Form 5471 filing requirement for the partner.
3. Form 8621 Passive Foreign Investment Company and Qualified Electing Fund reporting. Hedge funds actively invest in PFICs. Some U.S. hedge funds file the QEF election with respect to the PFIC investment at the fund level with the hedge fund’s U.S. Federal partnership tax return. If the fund files the QEF election, then the partner in the fund is not required to file the Form 8621 to make the QEF election separately with the partner’s respective U.S. Federal tax return. If the fund makes the QEF election at the fund level, the QEF’s income is included annually in the partner’s Schedule K-1 income that it receives from the fund. If the fund does not make the QEF election, then the U.S. partners in the fund must file the Form 8621 to make the QEF election with respect to each separate PFIC investment by the fund. The fund’s Schedule K-1 to the partner will provide sufficient information for the partner to report the QEF’s income on the partner’s Form 8621 filed with the U.S. Federal tax return.
4. U.S. Treas. Reg. Section 1.1411-10(g) Election with respect to CFC and PFIC/QEF income. The Schedule K-1 footnote disclosure will advise individual partner’s in the fund to make this election if the fund has included PFIC/QEF income in the partner’s Schedule K-1 taxable income. The election trues up the timing of the partner’s recognition of CFC and PFIC/QEF income. A shareholder in a foreign corporation may be required to pay U.S. Federal tax on undistributed income from a CFC or PFIC/QEF. This election allows the U.S. shareholder to recognize the undistributed CFC or PFIC/QEF income for Net Investment Income Tax purposes in the same year that it recognizes the income for regular tax purposes. Without the election, the Net Investment Income Tax on the income is deferred until the year when an actual distribution is received.
5. Foreign 8865 reporting for transfers to and ownership interests in foreign partnerships. The fund’s Schedule K-1 will provide sufficient information to the partners to file the Form 8865 to report their share of the fund’s contributions to foreign partnerships. If the partner is considered to have transferred $100,000 USD to a foreign partnership or if it owns 10% of the foreign partnership after the transfer by the fund, then the partner is within the Form 8865 filing threshold.
6. Form 8938 reporting for specified foreign financial assets. The hedge fund’s Schedule K-1 will often include a footnote disclosure regarding the Form 8938 filing requirements for individual partners. While an individual partner in a hedge fund generally may not be required to report the value of the fund’s investment in foreign corporations, PFICs and foreign partnerships on the partner’s Form 8938, it is advisable to consult a tax advisor.

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