Venture capital firms have been dubbed by some as the muscle behind the innovation. This is because many of them support a company by investing in it from the early stages through initial public offering. The Tax Cuts and Jobs Act enacted in 2018 substantially impacts venture capital accounting and the work done by a venture capital CPA.
Use of Pass-Through Entities
The Tax Cuts and Jobs Act strives to make the effective tax rates for investors and owners of pass-through entities line up with recently reduced corporate tax rates. Thanks to the new Section 199A, taxpayers may receive a 20 percent deduction of their share of business income as long as a qualified business generated the income.
Unfortunately, a large amount of venture capital funds will not be able to factor this into their bookkeeping because, in some cases, the investment income a venture capital firm generates does not meet the definition of qualified business income.
However, venture capital firms that work in a tiered structure may receive qualified business income from their investments in lower-tiered pass-through entities. This may allow them to factor the above 20 percent deduction into their venture capital tax planning.
How Changes to Individual Taxes May Impact Venture Capital Tax Planning
The Tax Cuts and Jobs Act changed individual taxes by reducing the top marginal tax rate from 39.6 percent down to 37 percent. This impacts venture capital accounting as it increases the level of personal risk investors may encounter.
There is a $250,000 per year limit for individuals and $500,000 limit for joint filers as of January 1, 2018. These limits are set to expire in 2025. These limits represent the aggregate of pass-through losses and all personal losses during the year from trade or business. As a result, individuals may not be able to deduct the losses from a management company or from a pass-through portfolio if they exceed these levels.
What Does the Balance Sheet of a Venture Capital Firm Look Like?
The typical structure of a venture capital firm is divided into two parts. There is the venture fund and then the venture fund manager.
Venture capital bookkeeping for the venture fund component would include:
1. Typical Limited Partnership Balance Sheet Assets:
- Portfolio Investments
- Receivables, such as dividends and interest and may also include capital contributions or subscriptions receivable
- Long-term debt
Equity or Partners Capital:
- Capital contributions less other expenses of capital
- Capital contributions fewer capital distributions
- Loss for the year/net income
2. Typical Fund Manager Balance Sheet
The venture fund manager is traditionally set up as a corporation. Its balance sheets should have cash, prepaid expenses, and receivables as assets. Liabilities should be expenses for marketing, administrative services, or professional services. Equity should be the portion of the fund manager’s owners retained earnings and profits or losses for the year.
Venture Capital Financial Advice
At Fusion CPA, we offer venture capital CFO business advisory services designed to help your venture capital firm maximize their tax incentives and identify opportunities for growth. Our goal is to serve as your partners, supplementing your business initiatives while helping your organization achieve its long-term and short-term goals.
We work with small to medium-size venture capital firms to help create personalized tax strategies that address unique challenges. Our venture capital financial advisers can assist with principal tax planning, preparing financial reports, auditing of financial statements, and can help ensure reporting accurately done. You can learn more about our services by clicking the button below to schedule a complimentary discovery call today!
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.