PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 125 Broad Street, 44th Floor New York, NY 10004
March 15, 2023
MEMORANDUM
Matter Number: 1023-00001
To: Marcus J. Calloway, Founder & Chief Investment Officer, Ironside Capital Management LP Renata Obasi, Senior Managing Director, Infrastructure, Ironside Capital Management LP
CC: Ironside Capital Management LP — Tax Department
From: Sylvia Hartwell, Partner, Tax Theresa Kim, Associate, Funds & Asset Management
Re: Review of Schedule K-1 (Form 1065) — ICM Cascadia Co-Invest, LP (EIN: 88-3921457) — Tax Year Ended December 31, 2022 — Ironside Capital Management LP as Limited Partner (99.99% Interest)
I. Executive Summary
Calderwood & Harkness LLP ("C&H") has been engaged to review the Schedule K-1 (Form 1065) issued by the fund administrator, Kendrick Thorne & Associates LLP ("Kendrick Thorne"), located at One Liberty Plaza, Suite 4100, New York, NY 10006, for Ironside Capital Management LP's ("Ironside") 99.99% limited partnership interest in ICM Cascadia Co-Invest, LP (the "Vehicle") for the tax year ended December 31, 2022. This memorandum sets forth our analysis and recommendations arising from that review.
ICM Cascadia Co-Invest, LP is a Delaware limited partnership formed on July 22, 2022, under a Certificate of Limited Partnership filed with the Delaware Secretary of State (DE SOS File Number 7439218). The Vehicle was organized for the specific purpose of co-investing alongside Meridian Infrastructure Partners Fund IV, LP ("Fund IV") in the acquisition of Cascadia Renewables Holdings, Inc. ("Cascadia"), a Portland, Oregon-based renewable energy and water infrastructure company.
The Vehicle's general partner is Meridian Infrastructure GP IV LLC (the "GP"), which holds a 0.01% general partnership interest and made a capital commitment of $30,000. Ironside holds a 99.99% limited partnership interest with a capital commitment of $299,970,000. Total committed capital of the Vehicle is $300,000,000. As of December 31, 2022, capital called to date totaled $22,500,000, representing a single capital call (Capital Call #1, dated August 15, 2022) equal to 7.5% of total committed capital. The unfunded commitment as of year-end stood at $277,500,000.
The Vehicle has been dormant since January 9, 2023, following the GP's issuance of a capital-call suspension notice and declaration of a Material Impediment Event under Section 7.04 of the Amended and Restated Limited Partnership Agreement (the "LP Agreement") due to the stalling of the underlying Cascadia acquisition. The Equity Purchase Agreement governing the acquisition was amended in November 2022 to extend the outside closing date from December 31, 2022 to March 31, 2023, but as of the date of this memorandum, the acquisition remains unconsummated.
For the 2022 tax year, the K-1 reflects no ordinary income or investment income of a material nature. The primary items reported are start-up and organizational expenses and syndication costs, resulting in a net ordinary loss allocation to Ironside. No capital gains or losses were realized, no guaranteed payments were made, and no distributions were paid. No unrelated business taxable income ("UBTI") is reported on the K-1.
With respect to state and local tax filing obligations, the Vehicle is domiciled in Delaware and is subject to the Delaware limited partnership annual franchise tax. Potential filing obligations in Oregon are analyzed below and, based on the facts as we understand them, no Oregon income tax filing is required for tax year 2022. No filing obligations exist in Washington, Idaho, or Massachusetts. The Vehicle's New York filing status should be confirmed with Kendrick Thorne, as discussed in Section VI.E below.
The balance of this memorandum provides a detailed analysis of the K-1, including a line-by-line review, partner's outside basis calculations, UBTI considerations, state tax filing requirements, allocation methodology, and a list of open reconciliation items to be confirmed with Kendrick Thorne.
II. Background — Vehicle Formation and Activity During Tax Year 2022
A. Formation and Organizational Timeline
The Vehicle was formed on July 22, 2022, when its Certificate of Limited Partnership was filed with the Delaware Secretary of State. Cascade Systems, located at 160 Greentree Drive, Suite 101, Dover, DE 19904, serves as the Vehicle's registered agent in Delaware.
The LP Agreement was executed on July 29, 2022, representing the first (and only) closing of the Vehicle. On the same date, Ironside and the GP entered into a Side Letter Agreement (the "Side Letter"), which, among other things, confirmed that no management fee would be charged to the co-investment vehicle and provided certain information rights, most-favored-nation protections, and reporting obligations specific to Ironside's investment.
Also at the first close on July 29, 2022, a placement-agent fee of $1,050,000 was paid to Rivermark Capital Markets Inc. ("Rivermark"), calculated as 0.35% of the Vehicle's total committed capital of $300,000,000. This fee compensated Rivermark for its services in connection with the syndication of interests in the Vehicle and was paid from proceeds of the first capital call.
Capital Call #1 was issued by the GP on August 15, 2022, in the amount of $22,500,000, representing 7.5% of the Vehicle's total committed capital. Ironside funded its 99.99% share of the capital call, or $22,497,750, with the GP funding the remaining $2,250 (representing its 0.01% interest).
No additional capital calls were issued during the remainder of the 2022 tax year. No subsequent closings occurred, and no additional limited partners were admitted to the Vehicle.
B. Use of Capital Call Proceeds
The proceeds of Capital Call #1 were deployed as follows:
The R&W insurance premium deposit of $4,875,000 was calculated at a rate of 2.5% on a coverage limit of $195,000,000, payable to Northgate Specialty Insurance Co. under Policy No. NSW-RI-2022-09814. The representation and warranty insurance policy was procured in connection with the contemplated acquisition of Cascadia and was intended to provide post-closing indemnification coverage to the buyer group. As the acquisition did not close, the policy has not been bound or activated, and the premium deposit remains a prepaid asset on the Vehicle's balance sheet.
The due-diligence costs and deposits of $12,790,000 represent a combination of investigatory expenses (legal, accounting, environmental, and technical due diligence of Cascadia and its subsidiaries) and certain refundable deposits and prepayments made in connection with the contemplated transaction. As discussed in further detail in Section III.E below, the proper characterization and bifurcation of these amounts is a key open item for confirmation with Kendrick Thorne.
The working-capital reserve of $3,500,000 represents cash held at Atlas National Bank, N.A. in a demand deposit account, maintained to fund ongoing administrative expenses and operating costs of the Vehicle.
C. Investment Activity
The Vehicle was organized to co-invest alongside Fund IV in the acquisition of 100% of the equity of Cascadia Renewables Holdings, Inc. through Cascadia Acquisition Corp., a newly formed acquisition subsidiary. The Vehicle's contemplated co-investment represented 28.57% of the total equity commitment of $1,050,000,000, with Fund IV providing the remaining 71.43% (approximately $750,000,000).
The Equity Purchase Agreement (the "EPA") was executed on September 15, 2022, at an enterprise value of $1,950,000,000, implying an EV/EBITDA multiple of approximately 14.1x based on Cascadia's fiscal year 2021 EBITDA of $138,000,000. The acquisition was to be funded through a combination of equity (the $1,050,000,000 total commitment from the Vehicle and Fund IV) and approximately $900,000,000 of senior secured credit facilities to be provided by Atlas National Bank, N.A. and Pinnacle Credit Partners (a $975,000,000 senior secured term loan had been committed, subject to customary conditions precedent).
The acquisition did not close during the 2022 tax year. On October 28, 2022, the Portland Metropolitan Water District issued a notice initiating the renegotiation of certain concession agreements held by Cascadia's operating subsidiaries. This development constituted a potential material adverse change under the terms of the EPA and triggered a period of uncertainty regarding the value and cash flow profile of the target's core assets.
In response, the parties to the EPA negotiated and executed the First Amendment to the EPA on November 22, 2022, which extended the outside closing date from December 31, 2022 to March 31, 2023. The First Amendment also modified certain closing conditions to accommodate the ongoing concession renegotiation process.
As a result of the foregoing, no investment was consummated during the 2022 tax year. As of December 31, 2022, the Vehicle's assets consisted solely of cash, prepaid deposits, and prepaid expenses. The Vehicle held no equity or debt securities, no real property, and no operating assets.
On January 9, 2023, the GP issued a capital-call suspension notice and declared a Material Impediment Event under Section 7.04 of the LP Agreement, effectively placing the Vehicle in a state of dormancy pending resolution of the concession renegotiation and a determination as to whether the acquisition would proceed, be restructured, or be abandoned.
No management fee is charged to the co-investment vehicle, as expressly provided in the Side Letter dated July 29, 2022. Carried interest of 10% above an 8% preferred return (compounded quarterly) is applicable to the GP's interest under the LP Agreement, but no carried interest was accrued, allocable, or distributable during the 2022 tax year given the absence of any investment returns.
III. Review of Schedule K-1 — Line-by-Line Analysis
Set forth below is our line-by-line review of the Schedule K-1 (Form 1065) issued to Ironside by Kendrick Thorne for the 2022 tax year.
A. Partner Information (Part I and Part II)
Part I — Information About the Partnership. The K-1 identifies the partnership as ICM Cascadia Co-Invest, LP, Employer Identification Number 88-3921457, with an entity address of c/o Cascade Systems, 160 Greentree Drive, Suite 101, Dover, DE 19904. The IRS Center where the partnership return was filed is indicated as Ogden, UT. The partnership's taxable year is the calendar year ended December 31, 2022. We note that this is the Vehicle's initial taxable year.
Part II — Information About the Partner. The K-1 identifies the partner as Ironside Capital Management LP, 590 Madison Avenue, 38th Floor, New York, NY 10022. The partner's entity type is indicated as a domestic partnership, and the partner is classified as a limited partner. Ironside's profit-sharing percentage is 99.99%, its loss-sharing percentage is 99.99%, and its capital-ownership percentage is 99.99%. These percentages are consistent with the LP Agreement.
Capital Account Analysis (Item L). The K-1 reports the following capital account information for Ironside:
The beginning capital account of $0 is consistent with the Vehicle's formation during the 2022 tax year. The capital contributed during the year of $22,497,750 represents Ironside's 99.99% share of the $22,500,000 capital call, with the remaining $2,250 attributable to the GP's 0.01% interest.
No withdrawals or distributions were made during the 2022 tax year. The ending capital account reflects contributions reduced by Ironside's allocable share of net losses and expenses allocated to it during the year.
The K-1 indicates that the capital account is reported using the tax basis method, which is consistent with the requirements of the IRS's revised Form 1065 instructions effective for tax years beginning in 2020 and later (requiring partnerships to report partner capital accounts on a tax basis). We will confirm with Kendrick Thorne that the tax-basis method was consistently applied and that no election was made to report capital accounts under GAAP or Section 704(b) book-value methodologies.
B. Ordinary Business Income (Loss) — Line 1
The K-1 reports a net ordinary loss on Line 1 for the 2022 tax year. This loss consists primarily of Vehicle-level operating expenses incurred from the date of formation (July 22, 2022) through December 31, 2022. The Vehicle did not generate any ordinary income during this period, as it conducted no active trade or business and consummated no investment.
The components of the ordinary loss, as we understand them based on our review and subject to confirmation with Kendrick Thorne, include the following:
(a) Legal and professional fees. A portion of the due-diligence costs incurred in connection with the contemplated Cascadia acquisition may have been characterized as currently deductible ordinary expenses, as distinguished from capitalized acquisition costs. The proper treatment of these costs depends on whether they are investigatory in nature (potentially deductible, subject to Section 195 limitations) or facilitative of the transaction (required to be capitalized under Treasury Regulations Section 1.263(a)-5). We address this bifurcation issue in further detail in Section III.E below.
(b) Fund administration fees. Fees payable to Kendrick Thorne & Associates LLP for fund administration, tax preparation, accounting, and K-1 preparation services during the period from formation through year-end.
(c) Registered agent fees. Annual fees payable to Cascade Systems for serving as the Vehicle's registered agent in Delaware, prorated for the partial 2022 year.
(d) Delaware franchise tax. The Vehicle is subject to an annual franchise tax of $300 for Delaware limited partnerships, prorated for the partial year from formation (July 22, 2022) through December 31, 2022.
(e) Miscellaneous administrative expenses. Bank fees, wire transfer charges, postage, and other de minimis operating costs incurred during the period.
Ironside's 99.99% allocable share of the net ordinary loss should be verified against the Vehicle's partnership return (Form 1065) to ensure consistency. We note that the magnitude of the ordinary loss should be relatively modest in comparison to the capital contributed, as the principal expenditures of the Vehicle (organizational expenses, syndication costs, R&W insurance, due-diligence deposits, and working-capital reserve) are either capitalized or deferred rather than currently deductible.
C. Organizational Expenses — Section 709 Analysis
The Vehicle incurred $285,000 in organizational expenses during the 2022 tax year. Organizational expenses generally include legal fees for the preparation of the partnership agreement, filing fees, and accounting fees incident to the creation of the partnership, as defined in Treasury Regulations Section 1.709-2(a).
Under IRC Section 709(b), a partnership may elect to deduct up to $5,000 of organizational expenses in the taxable year in which the partnership "begins business," with the $5,000 threshold reduced dollar-for-dollar by the amount by which total organizational expenses exceed $50,000. The remainder of organizational expenses not currently deductible is amortized ratably over the 180-month period beginning with the month in which the partnership begins business.
In the case of the Vehicle, total organizational expenses of $285,000 exceed the $50,000 threshold by $235,000. Because this excess ($235,000) exceeds $5,000, the $5,000 first-year deduction is fully phased out. Accordingly, if the Section 709(b) election is made, the entire $285,000 of organizational expenses would be amortized over 180 months beginning with the month in which the partnership begins business.
A threshold question, however, is whether the Vehicle has "begun business" for purposes of Section 709(b). The commencement of business for a partnership generally requires that the partnership has commenced the business activity for which it was organized. In the case of an investment partnership, business is generally considered to have commenced when the partnership makes its first investment. See Rev. Rul. 81-150, 1981-1 C.B. 119 (partnership begins business when it starts the business operation for which it was organized).
Because the acquisition of Cascadia was not consummated during the 2022 tax year and the Vehicle held only pre-closing deposits and cash reserves — and made no investment — the more conservative position is that the Vehicle has not yet "begun business" within the meaning of Section 709(b). Under this position, the Section 709(b) election is not yet available, and the $285,000 of organizational expenses should be capitalized as a deferred asset on the Vehicle's balance sheet, pending the commencement of business operations. Amortization would begin in the month in which the partnership commences business, which would occur if and when the Cascadia acquisition (or any alternative investment) is consummated.
We recommend confirming with Kendrick Thorne the position adopted on the Vehicle's Form 1065 with respect to the treatment of organizational expenses and the "business commenced" determination. If Kendrick Thorne has taken the position that the Vehicle began business during 2022 (for example, by treating the execution of the EPA or the deployment of due-diligence capital as the commencement of business), we would want to understand the basis for that position and evaluate whether it is supportable.
Recommendation: Verify with Kendrick Thorne the treatment adopted. The more conservative and, in our view, more defensible position is that business has not commenced and organizational expenses are capitalized.
D. Syndication Costs — Section 709(a)
The placement-agent fee of $1,050,000 paid to Rivermark Capital Markets Inc. constitutes a syndication cost under IRC Section 709(a). Syndication costs are defined as expenditures connected with the issuing and marketing of interests in a partnership, including brokerage fees, registration fees, legal fees related to the admission of partners, and printing costs for offering materials. See Treas. Reg. § 1.709-2(b).
Under the express provisions of Section 709(a), syndication costs are neither deductible nor amortizable. They must be capitalized for the life of the partnership and may only reduce gain (or increase loss) upon the dissolution and winding up of the partnership. This treatment applies regardless of whether the partnership has begun business. Unlike organizational expenses, syndication costs are not eligible for the Section 709(b) election to amortize over 180 months.
We have reviewed the K-1 to confirm that no deduction or amortization has been claimed for the placement-agent fee. The $1,050,000 should be reflected on the Vehicle's balance sheet (Schedule L) as a permanent capitalized asset. Because syndication costs are nondeductible and nonamortizable, they represent a nondeductible expenditure that reduces the partners' capital accounts without generating a current tax benefit. The treatment of this item on Lines 18 and 19 of the K-1 is discussed in Section III.O below.
Confirmation Item: Verify that the K-1 does not include any deduction for the placement-agent fee and that the $1,050,000 is properly reflected as a capitalized syndication cost on the Vehicle's balance sheet.
E. Start-Up Expenses — Section 195 Analysis
The due-diligence costs and deposits totaling $12,790,000 require careful bifurcation for federal income tax purposes. The proper characterization of these expenditures depends on their nature and the status of the underlying transaction.
Bifurcation Analysis. The $12,790,000 of due-diligence costs and deposits can generally be divided into the following categories:
(a) Investigatory costs — including legal, accounting, environmental, technical, and commercial due diligence of Cascadia and its subsidiaries — that are incurred to evaluate a prospective business prior to the taxpayer's entry into that business. These costs may qualify as start-up expenses under IRC Section 195 if they would otherwise be deductible had they been incurred in connection with an existing trade or business.
(b) Facilitative costs — including transaction-specific legal, accounting, and advisory fees that are directly related to and incurred in connection with the acquisition itself (e.g., drafting and negotiation of the EPA, structuring advice, regulatory filings). Under Treasury Regulations Section 1.263(a)-5, amounts paid to facilitate the acquisition of a trade or business must be capitalized and added to the basis of the acquired assets or equity. However, because the acquisition was not consummated, these costs may be subject to the "failed transaction" rules and potentially deductible as a loss under IRC Section 165.
(c) Refundable deposits and prepayments — including any deposits made to third parties (consultants, advisors, governmental agencies) that are refundable or represent prepayments for post-closing services. These items should be treated as assets (receivables or prepaid expenses) on the Vehicle's balance sheet rather than as expenses or losses.
Section 195 Treatment. To the extent that a portion of the $12,790,000 qualifies as start-up expenses under IRC Section 195, the deductibility of those expenses is governed by Section 195(b). Under that provision, a taxpayer may elect to deduct up to $5,000 of start-up expenses in the taxable year in which the active trade or business begins, with the $5,000 threshold reduced dollar-for-dollar by the amount by which total start-up expenses exceed $50,000. The remaining start-up expenses are amortized ratably over the 180-month period beginning with the month in which the active trade or business begins.
As with the organizational expense analysis in Section III.C above, the availability of the Section 195 deduction depends on whether the Vehicle has commenced an active trade or business. Because the acquisition did not close in 2022 and the Vehicle did not engage in any active business operations during the tax year, Section 195 deductions are not yet available. Start-up expenses should be capitalized and deferred until the commencement of the Vehicle's active trade or business.
Confirmation Item: We recommend that Ironside request from Kendrick Thorne a detailed schedule of the $12,790,000 in due-diligence costs and deposits, bifurcated by category (investigatory costs, facilitative costs, and refundable deposits/prepayments), along with the tax treatment applied to each category on the Vehicle's Form 1065. No current deduction should have been claimed for these costs on the K-1.
R&W Insurance Premium Deposit ($4,875,000). The R&W insurance premium deposit paid to Northgate Specialty Insurance Co. should be treated as a prepaid asset on the Vehicle's balance sheet. The deposit represents a payment toward an insurance policy that has not yet been bound or activated, as the acquisition has not closed. The premium deposit is not deductible as a current expense. If the acquisition closes and the policy is activated, the premium will be amortized over the policy term as an insurance expense (or, depending on structuring, capitalized as part of the acquisition cost). If the policy is terminated or the deposit is forfeited (e.g., if the acquisition is abandoned), the forfeited amount may be deductible as a loss under IRC Section 165. We will revisit this analysis as circumstances develop.
Working-Capital Reserve ($3,500,000). The working-capital reserve held at Atlas National Bank, N.A. is cash and is not an expense. It should be properly reflected as cash on the Vehicle's balance sheet (Schedule L) and does not appear as a deduction or expense item on the K-1.
F. Interest Income — Line 5
Minimal interest income may be reported on Line 5 of the K-1 from the Vehicle's cash held in its demand deposit account at Atlas National Bank, N.A. during the period from August 2022 through December 31, 2022. During this period, the Vehicle maintained a working-capital reserve of approximately $3,500,000, plus any other un-deployed funds that may have remained in the account prior to disbursement for due-diligence costs and deposits.
Ironside's 99.99% allocable share of any interest income earned on these balances should be reported on Ironside's own tax return as portfolio income. Given prevailing interest rates during the latter half of 2022 (the Federal Funds Rate rose from 2.50% in July 2022 to 4.50% by year-end), interest earned on a demand deposit or money market account balance of approximately $3,500,000 to $6,000,000 over a period of approximately four to five months would be expected to be in the range of approximately $40,000 to $100,000 for the Vehicle in the aggregate, depending on the account terms and the timing of disbursements. We will confirm the reported amount with Kendrick Thorne to ensure it is consistent with this estimate and with the deposit rates offered by Atlas National Bank.
G. Net Rental Real Estate Income / Other Rental Income — Lines 2, 3
Not applicable. The Vehicle has no rental activity, holds no real property, and owns no operating assets. Lines 2 and 3 of the K-1 should reflect zero.
H. Guaranteed Payments — Line 4
No guaranteed payments were made during the 2022 tax year. No management fee is charged to the co-investment vehicle, as expressly provided in the Side Letter dated July 29, 2022. No GP priority distributions or other payments that would constitute guaranteed payments under IRC Section 707(c) were made during the period. Line 4 of the K-1 should reflect zero.
I. Capital Gains / Losses — Lines 8, 9a, 9b, 9c, 10, 11
No capital gains or losses are reported on the K-1 for the 2022 tax year. The Vehicle made no investments and disposed of no assets during the tax year. Lines 8 (net short-term capital gain or loss), 9a (net long-term capital gain or loss), 9b (collectibles gain or loss), 9c (unrecaptured Section 1250 gain), 10 (net Section 1231 gain or loss), and 11 (other income or loss) should all reflect zero.
J. Section 1231 Gains/Losses — Line 10
Not applicable. The Vehicle did not engage in any transactions involving Section 1231 property during the 2022 tax year. Line 10 should reflect zero.
K. Other Deductions — Line 13
Line 13 of the K-1 reports other deductions, which may include items such as investment expenses (Section 212 expenses), charitable contributions, and other itemized deductions allocated to partners.
We recommend verifying any items reported on Line 13, including:
(a) Investment expenses under Section 212. If any portion of the Vehicle's expenses is characterized as investment advisory or management expenses, such amounts may be reported on Line 13. We note that, following the Tax Cuts and Jobs Act of 2017 ("TCJA"), miscellaneous itemized deductions subject to the 2% floor (including Section 212 expenses) are not deductible for individual taxpayers for tax years 2018 through 2025. However, this limitation does not directly affect Ironside, which is itself a partnership. The treatment of these expenses at the level of Ironside's individual partners will depend on the character of Ironside's partners and the applicability of the TCJA suspension.
(b) Other itemized deductions. Any other deductions allocated to Ironside under Line 13 should be identified and confirmed for proper categorization and reporting on Ironside's own return.
Confirmation Item: Confirm the nature and categorization of all items reported on Line 13 of the K-1.
L. Self-Employment Earnings — Line 14
Not applicable. Ironside is a limited partner in the Vehicle, and limited partners are generally excluded from self-employment tax on their distributive share of partnership income under IRC Section 1402(a)(13). No amounts should be reported on Line 14 as net earnings from self-employment.
M. Credits — Line 15
No tax credits are reported on the K-1 for the 2022 tax year. The Vehicle made no investment in qualified energy property, rehabilitated buildings, low-income housing, or other credit-generating assets during 2022. Because the acquisition of Cascadia was not consummated, no tax credits associated with Cascadia's renewable energy operations (such as production tax credits under Section 45 or investment tax credits under Section 48) have been earned or are allocable to the Vehicle's partners. Line 15 should reflect zero.
We note that if the acquisition is consummated in a future tax year, the potential availability of energy-related tax credits through Cascadia's operating subsidiaries will be a significant consideration and will be addressed in a separate analysis at that time.
N. Alternative Minimum Tax Items — Line 17
Line 17 of the K-1 reports the partner's share of alternative minimum tax ("AMT") preference items and adjustments. For the 2022 tax year, any AMT items would likely be minimal or nonexistent, as the Vehicle's only activity consisted of incurring organizational and administrative expenses, which do not typically generate AMT preference items.
To the extent that organizational expenses or start-up expenses are amortized under Sections 709(b) or 195, the amortization period for AMT purposes could differ from the regular tax treatment, potentially creating an AMT adjustment. However, as discussed in Sections III.C and III.E above, no amortization is expected to have commenced during 2022 because the Vehicle has not yet begun business.
Confirmation Item: Review Line 17 of the K-1 for any AMT items and confirm that no unintended adjustments have been reported.
O. Tax-Exempt Income and Nondeductible Expenses — Lines 18, 19
Tax-Exempt Income (Line 18a). Confirm that no tax-exempt income is reported on Line 18a. The Vehicle did not hold any tax-exempt securities or receive any tax-exempt income during the 2022 tax year.
Nondeductible Expenses (Line 18c). The $1,050,000 of syndication costs (the placement-agent fee paid to Rivermark Capital Markets Inc.) constitutes a nondeductible expenditure under IRC Section 709(a). This amount should be reflected on the K-1 as a nondeductible expense that reduces the partner's capital account without generating a current tax deduction. We will verify that the K-1 properly reports Ironside's 99.99% share of the syndication cost ($1,049,895) as a nondeductible expense on Line 18c (or the applicable code on the supplemental schedule).
This treatment is important for purposes of computing Ironside's ending capital account (which should be reduced by the nondeductible syndication costs) and for tracking the partners' outside basis (which is also reduced by nondeductible expenditures).
P. Distributions — Line 19
No distributions were made to Ironside or any other partner during the 2022 tax year. Line 19 of the K-1 should reflect zero for both cash distributions and property distributions. We confirm that this is consistent with our understanding of the Vehicle's activities during 2022.
Q. Partner's Capital Account Analysis
The following is a summary reconciliation of Ironside's capital account for the 2022 tax year as reported on the K-1:
The ending capital account should reconcile to the Vehicle's Schedule L (balance sheet) and Schedules M-1 and M-2 as filed with the Form 1065. We recommend that Ironside's tax department verify this reconciliation and confirm the accuracy of the ending capital account balance.
Confirmation Item: Request from Kendrick Thorne a copy of the Vehicle's Schedules L, M-1, and M-2 and verify that Ironside's ending capital account on the K-1 reconciles to the Vehicle's books and records.
IV. Partner's Tax Basis Analysis
A. Outside Basis Calculation
Ironside's initial outside basis in its partnership interest in the Vehicle is equal to the cash contributed during the 2022 tax year: $22,497,750 (Ironside's 99.99% share of the $22,500,000 capital call).
Ironside's outside basis is adjusted as follows for the 2022 tax year:
Several observations are warranted:
No risk of basis going below zero. Given the magnitude of Ironside's capital contribution ($22,497,750) relative to the expected net losses and nondeductible expenditures allocated to it for 2022, there is no risk that Ironside's outside basis will be reduced to zero or below. The aggregate losses and nondeductible expenditures are expected to be modest — likely no more than approximately $1,400,000 in the aggregate (consisting primarily of operating expenses and syndication costs). Accordingly, the Section 704(d) basis limitation on the deductibility of partnership losses is not expected to apply.
Unfunded commitment does not increase basis. Ironside's unfunded capital commitment of $277,470,300 ($299,970,000 total commitment less $22,497,750 contributed) does not increase its outside basis until the commitment is actually funded through a capital call. An unfunded commitment is not treated as a contribution or a partnership liability for purposes of IRC Section 752. This is consistent with the well-established principle that a partner's outside basis is increased only by actual contributions of money or property and by the partner's share of partnership liabilities. See IRC §§ 722, 752.
Partnership liabilities. The Vehicle has no outstanding debt as of December 31, 2022. The senior secured term loan from Atlas National Bank and Pinnacle Credit Partners ($975,000,000) was committed for the acquisition of Cascadia through Cascadia Acquisition Corp. and was never drawn because the acquisition did not close. The Vehicle itself has no borrowings, guarantees, or other liabilities that would increase Ironside's outside basis under Section 752.
B. At-Risk Rules — Section 465
Under IRC Section 465, Ironside's amount at risk with respect to its interest in the Vehicle equals the amount of cash contributed by Ironside ($22,497,750). The Vehicle has no nonrecourse debt, and Ironside is not personally liable for any amounts beyond its capital contribution and unfunded commitment (which does not count as an amount at risk until funded).
Because Ironside's allocable share of the Vehicle's losses for 2022 is expected to be significantly less than its amount at risk, the Section 465 at-risk limitation is not expected to limit the deductibility of any losses allocated to Ironside from the Vehicle for the 2022 tax year.
C. Passive Activity Rules — Section 469
Under IRC Section 469, Ironside, as a limited partner in the Vehicle, is generally treated as having a passive activity interest. Losses allocated to Ironside from the Vehicle are therefore characterized as passive activity losses, subject to the passive activity loss limitation rules.
However, Ironside is itself a partnership (not an individual taxpayer), and the ultimate application of the passive activity rules depends on the character and circumstances of Ironside's own partners. The passive activity rules apply at the individual (or closely-held C corporation) level, and Ironside's distributive share of the Vehicle's losses will flow through to Ironside's partners on their respective K-1s. Each of Ironside's partners will then apply the passive activity rules based on their own individual circumstances, including whether they have sufficient passive income from other sources to absorb passive losses.
For purposes of Ironside's own reporting, the following observations apply:
(a) Ironside did not materially participate in the activities of the Vehicle during 2022. The Vehicle was dormant for most of the year and made no investment. Material participation by Ironside in the Vehicle's activities is neither claimed nor expected.
(b) Passive losses allocated to Ironside from the Vehicle may be suspended at the partner level if Ironside's individual partners do not have sufficient passive income from other sources to offset those losses. Alternatively, to the extent Ironside's partners have passive income from other activities, the passive losses from the Vehicle may be deductible against such income.
(c) Upon a disposition of Ironside's entire interest in the Vehicle (or upon dissolution of the Vehicle), any suspended passive losses would be released and deductible in full. See IRC § 469(g).
Given the relatively modest amount of losses expected from the Vehicle for the 2022 tax year, the passive activity limitation is unlikely to have a material impact on Ironside's overall tax position.
V. UBTI Analysis
A. General Framework
The rules governing Unrelated Business Taxable Income ("UBTI") under IRC Sections 511 through 514 are relevant to the extent that any of Ironside's underlying investors include tax-exempt entities, such as pension funds, endowments, foundations, or other organizations described in IRC Section 501(c). Tax-exempt investors in Ironside would be subject to UBTI to the extent the income flowing through from the Vehicle constitutes unrelated business taxable income.
The K-1 issued by the Vehicle should indicate on Line 20 (or the supplemental information schedule) whether any items of UBTI are reported for the 2022 tax year.
B. 2022 UBTI Determination
Based on our review, the Vehicle generated no UBTI during the 2022 tax year. The analysis supporting this conclusion is as follows:
(a) No active trade or business. The Vehicle did not conduct an active trade or business during 2022. The contemplated acquisition of Cascadia was not consummated, and the Vehicle's activities were limited to organizational, administrative, and due-diligence functions. Organizational activities incident to the formation of a partnership do not constitute the conduct of an unrelated trade or business for UBTI purposes.
(b) No debt-financed income. The Vehicle has no leverage and did not incur any indebtedness during the 2022 tax year. The $975,000,000 senior secured term loan from Atlas National Bank and Pinnacle Credit Partners was a commitment for the acquisition of Cascadia through Cascadia Acquisition Corp. and was never drawn. The Vehicle itself has no borrowings. Accordingly, there is no debt-financed property within the meaning of IRC Section 514, and no debt-financed income subject to UBTI.
(c) Interest income excluded. Interest income earned on cash deposits held at Atlas National Bank, N.A. is excluded from UBTI under the general exclusion for investment income provided by IRC Section 512(b)(1). This exclusion applies because the interest income is not derived from debt-financed property and is not otherwise connected with an unrelated trade or business.
(d) Organizational and start-up expenses. Organizational expenses, start-up expenses, and syndication costs are capital-type expenditures and do not generate UBTI, either positively or negatively.
Confirmation Item: Verify that Line 20 of the K-1 reflects no UBTI items for the 2022 tax year.
C. Prospective UBTI Considerations
If the acquisition of Cascadia is reactivated and consummated in a future tax year, the UBTI analysis will require revisiting in light of the following considerations:
(a) Operating income. Cascadia's operating subsidiaries conduct active businesses in renewable energy and water infrastructure. If the Vehicle acquires a direct or indirect interest in these operations, income derived from the operating businesses may constitute UBTI for tax-exempt investors in Ironside, depending on the organizational structure (e.g., whether blocker corporations or other intermediate entities are interposed to shield tax-exempt investors from UBTI).
(b) Debt-financed income. If the acquisition is funded in part through debt at the Vehicle level or at the level of Cascadia Acquisition Corp. (as contemplated by the original transaction structure, which included approximately $900,000,000 of senior secured credit facilities), a portion of the income allocable to tax-exempt investors may constitute debt-financed income subject to UBTI under IRC Section 514.
(c) blocker structures. The LP Agreement and Side Letter should be reviewed to determine whether any blocker entity structures have been contemplated or implemented for the benefit of tax-exempt investors in Ironside. If no blocker is in place, tax-exempt investors may face material UBTI exposure upon consummation of the acquisition.
C&H will provide a detailed UBTI analysis if and when the transaction is reactivated. We recommend that Ironside's tax department flag this issue for its tax-exempt investor base as part of its ongoing investor communications.
VI. State and Local Tax Filing Requirements
A. Delaware
ICM Cascadia Co-Invest, LP is organized as a Delaware limited partnership. Delaware does not impose an income tax on limited partnerships or their partners with respect to income earned by the partnership. However, the Vehicle is subject to the Delaware annual franchise tax for limited partnerships, which is $300 per year, due on June 1 of each year.
Ironside, as a Delaware limited partnership itself, must consider whether its allocable share of the Vehicle's income or loss creates any incremental Delaware filing obligation. Because the Vehicle is domiciled in Delaware but conducted no business in Delaware during the 2022 tax year (its target assets are located in Oregon, Washington, and Idaho, and its administrative activities were conducted from New York), there is no Delaware income tax consequence for Ironside beyond its own existing Delaware filings and franchise tax obligations.
No additional Delaware income tax filings are required for Ironside with respect to the Vehicle for the 2022 tax year.
B. Oregon
Cascadia Renewables Holdings, Inc. is an Oregon corporation with principal operations in Oregon. The Vehicle was organized to acquire Cascadia, and certain due-diligence activities may have been conducted in Oregon during the 2022 tax year, including site visits to Cascadia's facilities and meetings with Cascadia management at its offices at 1100 SW Sixth Avenue, Suite 1800, Portland, OR 97204.
However, during the 2022 tax year, the Vehicle did not acquire Cascadia, did not own any Oregon-situs assets, and did not conduct an active trade or business in Oregon. The question is whether the due-diligence activities conducted in Oregon are sufficient to create nexus for Oregon income tax purposes.
Under Oregon law, a partnership (and its nonresident partners) is subject to Oregon income tax on income derived from sources within Oregon. Oregon also applies an economic nexus standard and factor-presence test for businesses operating in the state. However, due-diligence activities alone — such as site visits, document reviews, and meetings with target company management — generally do not constitute "doing business" in Oregon and are not sufficient to create nexus for income tax purposes, particularly where no investment was consummated and no income was derived from Oregon sources.
Recommendation: No Oregon income tax filing is required for the Vehicle or for Ironside with respect to the Vehicle for the 2022 tax year. However, if the acquisition closes in a future tax year, both the Vehicle (as an indirect owner of Oregon-situs assets through Cascadia Acquisition Corp.) and Ironside (as a partner in the Vehicle) would likely have Oregon filing obligations and be subject to Oregon income tax on apportioned income. Oregon's apportionment methodology and applicable tax rates should be analyzed at that time. We recommend continuing to monitor developments with respect to the transaction and Oregon filing requirements.
C. Washington
Washington State does not impose a personal income tax or a partnership income tax. Washington's Business & Occupation ("B&O") tax applies to business activities conducted in Washington. The Vehicle had no Washington business activities during the 2022 tax year and derived no income from Washington sources. Cascadia's operations include assets in Washington, but because the Vehicle did not acquire Cascadia during 2022, no Washington B&O tax filing is required.
No Washington filing is required for the Vehicle or Ironside with respect to the Vehicle for the 2022 tax year.
D. Idaho
Idaho imposes income tax on partnerships and their partners with respect to Idaho-source income. The Vehicle had no Idaho-source income during the 2022 tax year and conducted no business activities in Idaho. Although Cascadia's operations include certain assets in Idaho, the Vehicle did not acquire Cascadia during 2022.
No Idaho income tax filing is required for the Vehicle or Ironside with respect to the Vehicle for the 2022 tax year.
E. New York
Ironside Capital Management LP is headquartered at 590 Madison Avenue, 38th Floor, New York, NY 10022. Ironside's allocable share of the Vehicle's income or loss for the 2022 tax year flows through to Ironside's New York tax filings (including Ironside's filing of its own New York partnership return and the reporting of New York-source income, if any, allocable to Ironside's New York-resident partners).
A separate question is whether the Vehicle itself has a New York partnership return filing obligation. Under New York Tax Law Section 658(c), a partnership that has income derived from New York sources or that has a resident partner is generally required to file a New York partnership return (Form IT-204). Even if the Vehicle has no New York-source income, it may be considered to be "doing business" in New York if its administrative activities are conducted from Ironside's New York office or from the offices of Kendrick Thorne & Associates LLP in New York (One Liberty Plaza, Suite 4100, New York, NY 10006).
If the Vehicle's day-to-day administrative functions — including fund administration, accounting, tax preparation, and correspondence — are performed by Kendrick Thorne from its New York office, the Vehicle may be deemed to have a presence in New York sufficient to trigger a filing obligation. However, if the Vehicle has no New York-source income and does not otherwise conduct business in New York, the filing may be informational in nature and would not result in a New York tax liability.
Recommendation: Confirm with Kendrick Thorne whether a New York partnership return (Form IT-204) was filed for the Vehicle for the 2022 tax year. If no return was filed, consider whether a protective filing is advisable to avoid potential penalties for failure to file. Ironside will report its share of the Vehicle's income or loss on its own New York filings regardless of the Vehicle's filing status.
F. Massachusetts
Meridian Infrastructure Partners LP and Meridian Infrastructure GP IV LLC are based in Boston, Massachusetts. However, the GP's location alone does not generally create a nexus for the Vehicle or for Ironside in Massachusetts. The Vehicle conducted no business activities in Massachusetts during the 2022 tax year, derived no Massachusetts-source income, and has no partners that are Massachusetts residents (Ironside is a New York limited partnership, and the GP is a Delaware LLC with a principal office in Massachusetts).
No Massachusetts income tax filing is required for Ironside with respect to the Vehicle for the 2022 tax year.
VII. Allocation Methodology and Special Allocation Provisions
The LP Agreement provides for allocations of income, gain, loss, deduction, and credit in accordance with the partners' respective percentage interests (GP: 0.01%; Ironside as LP: 99.99%). These allocations are subject to the regulatory allocations required under Treasury Regulations Sections 1.704-1(b) and 1.704-2 to ensure the allocations have "substantial economic effect." The LP Agreement includes the standard regulatory allocation provisions, including:
(a) Qualified income offset — ensuring that a partner who unexpectedly receives an adjustment, allocation, or distribution that creates or increases a deficit capital account balance is allocated items of income and gain sufficient to eliminate such deficit as quickly as possible (Treas. Reg. § 1.704-1(b)(2)(ii)(d)).
(b) Minimum gain chargeback — requiring that if there is a net decrease in partnership minimum gain during a taxable year, each partner is allocated items of income and gain for that year equal to the partner's share of the net decrease in minimum gain (Treas. Reg. § 1.704-2(f)). This provision is not currently applicable because the Vehicle has no nonrecourse debt and no minimum gain.
(c) Partner nonrecourse debt minimum gain chargeback — a similar chargeback provision applicable to partner nonrecourse debt (Treas. Reg. § 1.704-2(i)(4)). Also not currently applicable.
The carried interest provision of the LP Agreement (10% carried interest above an 8% preferred return, compounded quarterly, applicable to the GP) is relevant only upon the realization of investment gains by the Vehicle. Because no investment was made and no gains were realized during the 2022 tax year, no carried interest allocations were made or are reflected on the K-1.
Confirmation Item: Verify that the K-1 allocations are consistent with the LP Agreement allocation provisions and that no special allocations were made outside the ordinary 99.99%/0.01% split for the 2022 tax year. Confirm with Kendrick Thorne that the allocation waterfall properly reflects the applicable percentage interests for all items of income, gain, loss, deduction, and credit reported for 2022.
VIII. Reconciliation Items and Open Questions for Kendrick Thorne & Associates LLP
Based on our review of the K-1 and the matters discussed in this memorandum, we have identified the following items that should be confirmed or reconciled with Kendrick Thorne & Associates LLP. We recommend that Ironside's tax department transmit these questions to Kendrick Thorne promptly so that any necessary adjustments can be made before Ironside's tax returns are finalized.
1. Organizational expenses ($285,000). Confirm whether the $285,000 of organizational expenses has been capitalized as a deferred asset or whether the Vehicle elected the Section 709(b) deduction/amortization. Confirm the "business commenced" determination underlying the treatment adopted.
2. Placement-agent fee ($1,050,000). Confirm that the $1,050,000 placement-agent fee paid to Rivermark Capital Markets Inc. has been capitalized as a syndication cost under IRC Section 709(a) and that no amortization or current deduction has been claimed.
3. Due-diligence costs ($12,790,000). Request a detailed schedule bifurcating the $12,790,000 of due-diligence costs and deposits into the following categories: (a) investigatory/start-up expenses under Section 195, (b) facilitative/acquisition costs under Treasury Regulations Section 1.263(a)-5, and (c) refundable deposits and prepaid assets. Confirm the tax treatment applied to each category.
4. R&W insurance premium deposit ($4,875,000). Confirm that the $4,875,000 R&W insurance premium deposit paid to Northgate Specialty Insurance Co. is treated as a prepaid asset on the Vehicle's balance sheet and is not included in any expense or deduction item on the K-1.
5. Working-capital reserve ($3,500,000). Confirm that the $3,500,000 working-capital reserve is reflected as cash on the Vehicle's balance sheet and is not treated as an expense.
6. Interest income on cash balances. Confirm the amount of interest income earned on the Vehicle's cash balances during the period from August 2022 through December 2022 and verify that it is properly reported on Line 5 of the K-1.
7. Ending capital account reconciliation. Provide the Vehicle's Schedules L, M-1, and M-2 and verify that Ironside's ending capital account as reported on the K-1 reconciles to the Vehicle's balance sheet and reconciliation schedules.
8. UBTI items. Confirm that no UBTI items are reported on Line 20 of the K-1.
9. New York filing status. Confirm whether a New York partnership return (Form IT-204) was filed for the Vehicle for the 2022 tax year. If not, advise whether a protective filing is recommended.
10. Capital account reporting method. Confirm that the tax-basis method was used for capital account reporting on the K-1, consistent with IRS requirements for tax years beginning in 2020 and later.
We recommend that Ironside's tax department compile responses from Kendrick Thorne and transmit them to C&H for review prior to finalizing Ironside's own tax returns.
IX. Recommendations
Based on the foregoing analysis, C&H offers the following recommendations:
1. Incorporate K-1 data into tax returns. Ironside's tax department should incorporate the K-1 data from the Vehicle into Ironside's federal and state income tax returns for the year ended December 31, 2022, subject to resolution of the open items identified in Section VIII above. The allocable share of the Vehicle's net ordinary loss, interest income, and nondeductible expenditures should be properly reflected on Ironside's Form 1065 and K-1s issued to Ironside's own partners.
2. No additional state filings required for 2022. Based on our analysis, no state income tax filings appear necessary for the Vehicle or for Ironside with respect to the Vehicle in Oregon, Washington, Idaho, or Massachusetts for the 2022 tax year. The Vehicle's New York filing status should be confirmed with Kendrick Thorne as described in Recommendation 3 and Section VI.E above.
3. Follow up with Kendrick Thorne. Ironside should follow up with Kendrick Thorne on the open items identified in Section VIII of this memorandum, with particular emphasis on: (a) the characterization and tax treatment of organizational expenses ($285,000) and the "business commenced" determination; (b) the bifurcation and treatment of due-diligence costs ($12,790,000); and (c) the Vehicle's New York filing status. C&H is available to participate in these discussions or to review Kendrick Thorne's responses.