Key Takeaways
- • Private credit and other alternative vehicles structured as partnerships generate Schedule K-1 forms that typically arrive in August or September, often forcing taxpayers to file extensions rather than meeting the April deadline, according to Financial Planning.
- • Wealthy investors holding enough in alternatives that operate across state lines may be required to file tax returns in every state where the vehicle does business, with one Mercer Advisors client required to file in three or four states.
- • Samuel Diarbakerly, founder and CEO of Generation Capital Advisors, says clients are growing disillusioned with alternatives and predicts the "alts mania" will fade as investors reassess the upside against tax complexity and liquidity constraints.
- • Advisors warn that clients may face higher tax preparation fees, amended returns, "phantom income" tax liabilities on undistributed earnings, and fraud risk when filing extensions.
- • Generation Capital Advisors continues to use alternatives for nontaxable accounts and entities such as retirement accounts, family foundations and charitable lead annuity trusts.
Summary
Investors in private credit are facing tax complications that many clients and advisors did not anticipate, according to Financial Planning, adding to concerns about liquidity and credit quality in the asset class. Because investors in private credit vehicles structured as partnerships receive Schedule K-1 forms, which typically arrive in August or September, taxpayers often must file extensions instead of meeting the usual April deadline.
Samuel Diarbakerly, founder and CEO of Boston-based wealth manager Generation Capital Advisors, said the rise of alternative investments has created substantial tax complexity. He noted that wealthy individuals holding sufficient amounts in alternatives that do business in other states may be required to file returns in each of those states. He also said that because few financial advisors are tax professionals, clients may fail to file extensions and subsequently need to submit amended returns. He cited a client who inherited a hedge fund from their parents and found that the tax burden was difficult to meet while exiting, since redemptions were limited to once a year and 10% annually. "I think a lot of wealthy people are kind of sick of alternatives because of that," he said.
David Askew, managing partner overseeing Mercer Advisors' Southern California advisory teams, said clients face higher tax preparation fees depending on the number of Schedule K-1 forms they receive. He said some clients were required to file in three or four states because of a private equity fund's domicile, and warned that do-it-yourself filers may not anticipate multistate obligations. Askew advised clients who file extensions to obtain Identity Protection PINs or passwords from tax authorities to guard against fraudsters filing in their names to claim refunds. He also recommended reassessing tax projections midyear, partnering with a CPA, and keeping extra liquidity to cover potential tax on "phantom income" earned but not distributed. He said clients are second-guessing their investment decisions and wish they had understood the tax impact before investing.
Diarbakerly and Askew both said alternatives remain useful in certain contexts. Generation Capital Advisors uses them where appropriate, particularly in nontaxable accounts and entities such as retirement accounts, family foundations and charitable lead annuity trusts. Askew said private credit still holds strong appeal for clients, but that tax considerations should be understood before committing capital.
Samuel Diarbakerly, founder and CEO of Boston-based wealth manager Generation Capital Advisors, said the rise of alternative investments has created substantial tax complexity. He noted that wealthy individuals holding sufficient amounts in alternatives that do business in other states may be required to file returns in each of those states. He also said that because few financial advisors are tax professionals, clients may fail to file extensions and subsequently need to submit amended returns. He cited a client who inherited a hedge fund from their parents and found that the tax burden was difficult to meet while exiting, since redemptions were limited to once a year and 10% annually. "I think a lot of wealthy people are kind of sick of alternatives because of that," he said.
David Askew, managing partner overseeing Mercer Advisors' Southern California advisory teams, said clients face higher tax preparation fees depending on the number of Schedule K-1 forms they receive. He said some clients were required to file in three or four states because of a private equity fund's domicile, and warned that do-it-yourself filers may not anticipate multistate obligations. Askew advised clients who file extensions to obtain Identity Protection PINs or passwords from tax authorities to guard against fraudsters filing in their names to claim refunds. He also recommended reassessing tax projections midyear, partnering with a CPA, and keeping extra liquidity to cover potential tax on "phantom income" earned but not distributed. He said clients are second-guessing their investment decisions and wish they had understood the tax impact before investing.
Diarbakerly and Askew both said alternatives remain useful in certain contexts. Generation Capital Advisors uses them where appropriate, particularly in nontaxable accounts and entities such as retirement accounts, family foundations and charitable lead annuity trusts. Askew said private credit still holds strong appeal for clients, but that tax considerations should be understood before committing capital.
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