Additional disclosures in the annual Form 990 and possible taxable implications — Many associations are investing in alternatives due to the ongoing economic recovery and low rate of returns from traditional investments. Endowment and board designated funds need to achieve investment targets, which can be near impossible to make with the average returns from mutual funds and managed accounts. Alternative investments provide the allure of increased returns, albeit at an increased risk. Many associations have been successful at hitting higher returns through alternative investments. These investments do come with added oversight and considerations for additional disclosures to the government in certain ownership situations or because of certain transactions.
Typical alternative investments are hedge funds, private equity funds, commodities, and private investment funds. When you dig a little deeper into the investment vehicle these alternatives utilize, you find partnerships and Limited Liability Companies (LLC). Most, with the exception of a select few, are not publicly traded on an open market. These investment types require careful analysis to value and record under Generally Accepted Accounting Principles (GAAP), as well as tax review for issues involving special disclosure options. Here are some of the main considerations an association’s financial officer should review annually with regard to alternative investment activity.
If invested in a LLC or partnership, it should be reviewed to understand the origin, whether foreign or domestic. Investment holdings of more than $100,000 in foreign sourced investments require disclosure in Schedule F of the annual Federal Form 990. Additionally, certain activity such as a current investment of $100,000 or more could require additional forms for completion and submission with Form 990. Potential forms can include Form 926 for foreign corporations, and Form 8865 for foreign partnerships. Form 8621 is necessary if the association is a shareholder in a Passive Foreign Investment Company (PFIC) or a qualified electing fund. Identifying these entities and determining the forms to complete may require assistance from an international tax specialist.
Partnerships and LLCs provide K-1s at year-end summarizing the taxable information for the recipient. An association could be subject to unrelated business income from debt-financed property reported on the K-1. Investment managers report details of nonprofit unrelated activity in a special place on a K-1 as footnotes or additional disclosures behind the printed form. This can require the association to file Federal Form 990-T. State taxable income can be disclosed in the K-1 nonprofit section, reporting the states that have nexus by location, requiring one or more state income tax returns in addition to Form 990-T.