Another Thing for Neurotic VCs to Worry About
A couple of weeks ago, Erin wrote about a little tax rule designed to dissuade more than 2% of a fund’s LP interests from changing hands in a single year. The danger, as she reported, is that any fund that sees more than 2 percent of its LP interests sell on the secondary market is in danger of losing its “private” status, and the related tax benefits. Erin was writing about buyout funds, but I gathered the rule was applicable to venture funds as well, so earlier today, I called up Ben Berk, an attorney in the tax strategies and planning group of Howard Rice in San Francisco. Ben told me much more about the rule, and whether, given the uptick in venture shares trading around on the secondary market these days, VCs should be concerned about it. Can you put this 2 percent rule into some context for us? Sure, it’s one of at least three safe harbors that people try to structure into. The first safe harbor is that if 90 percent of the income of a fund is qualifying income -- basically capital gains dividends and interest income -- then you’re not going to be considered to be publicly traded. If in any year, that qualifying income is less than 90 percent, then you have to move on to a second test.
