Podcast: Investing in Flow-Through Entities

The Alternative Edge

Welcome to another episode of Weaver: Beyond the Numbers, The Alternative Edge. In this episode, tax professionals Blayne Lowary and Minh Dinh focus on investment funds and the essential aspects surrounding investments in flow-through entities.

Key Points:

• Flow-through entities like LLCs and partnerships pass earnings or losses directly to investors who bear the tax implications via a Schedule K-1. This structure avoids entity-level taxation, but it requires investors to report income or deductions individually.
• Investors, especially non-U.S. and tax-exempt individuals, may face complications like tax filings in the U.S. and the potential for effectively connected income (ECI) or unrelated business taxable income (UBTI). Strategic solutions such as using blocker entities can help mitigate these challenges and preserve tax-exempt status.
• Due diligence is essential, as tax filings at the entity level can cascade to investors, potentially delaying K-1 issuance and tax reporting. Investors must manage expectations around timing and prepare for state tax considerations that arise from entity activities.

The hosts discuss how flow-through investments refer to investments made in entities structured as limited partnerships or limited liability companies. The tax-paying burden for these entities, instead of the company, falls on the investors who receive a Schedule K-1 annually, reporting their share of income and deductions with the original characteristics intact.

Speaking to the nuances that investors should keep in mind, Lowary says, “Depending on your investor base, there’s a few things to consider. The income generated by a portfolio company structured as pass through is usually considered income effectively connected with a U.S. trade or business, and it’s often referred to as ECI. It’s also considered unrelated business taxable income or UBTI.”

Minh advises clients to be prepared for state tax filings regarding portfolio companies. Investors should also be in the loop about state extensions, tax withholding requirements and composite election considerations. While flow-through investments offer unique benefits, they come with their tax implications and timing considerations. It is crucial for investors to fully understand these nuances before making their investment decisions.

Subscribe and listen to future episodes of Weaver: Beyond the Numbers, The Alternative Edge, on Apple Podcasts or Spotify.

©2024