Taxes, paperwork and the boring parts

The K-1

A fund is a partnership, so it does not pay tax itself. Instead it sends each LP a Schedule K-1 every year reporting their share of the fund’s income, gains, losses and deductions. You report those on your own return whether or not the fund sent you any cash. In early years the K-1 usually shows small losses from fees. In later years it can show large gains in a year when a company is sold.

Why it arrives late

The fund cannot finish its K-1s until every portfolio company has sent its own tax information, and private companies are slow. K-1s are due March 15 but are routinely delivered in the summer. Almost every LP files an extension every year. Tell your accountant in advance and it becomes routine.

State taxes

If the fund’s companies are in several states, the K-1 may show income allocated to states where you do not live. Whether you owe anything there depends on amounts and thresholds. This is a question for your accountant, and it is one reason to have one.

The QSBS exclusion

United States tax law allows a large exclusion on gains from qualified small business stock held more than five years, and those gains can flow through a fund to its LPs. Many venture-backed companies qualify. This can materially change your after-tax result, so ask the GP whether they track QSBS eligibility for each investment.

What you will be asked for

• Tax identification and residency details for the subscription documents.
• Identity documents for anti-money-laundering checks, which are legally required.
• A signature, usually electronic, on the subscription agreement and a wire for each capital call.
• Occasional updates if your address, entity or tax status changes.

Keep a folder

One folder, physical or digital, with the LPA, the subscription agreement, every capital call notice, every distribution notice, and every K-1. Ten years is a long time, and the fund will not always be able to reconstruct your history for you.

You have finished the course

You now know more about how a venture fund works than most people who are eligible to invest in one. If you want to see how Zoha applies all of this, read how LPs work with Zoha. If you are still deciding, come back to any lesson whenever you need it.