1023-00003 · Ironside Capital Management LP · Analysis

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LEGAL MEMORANDUM OF IRONSIDE CAPITAL MANAGEMENT LP IN SUPPORT OF POSITIONS TAKEN ON 2021 PARTNERSHIP RETURN (FORM 1065)

September 6, 2023

FROM:

Sylvia Hartwell, Partner Calderwood & Harkness LLP 1251 Avenue of the Americas, 40th Floor New York, NY 10020 Telephone: (212) 558-4000 Facsimile: (212) 558-3588

Email: shartwell@calderwoodharkness.com

TO:

Timothy J. Albrecht Revenue Agent (Badge No. 74-28193) IRS Large Business & International Division 290 Broadway New York, NY 10007

Eric S. Lundgren Attorney, IRS Office of Chief Counsel Large Business & International Branch 5 290 Broadway New York, NY 10007

RE: Ironside Capital Management LP (EIN 83-2741956) — Examination of 2021 Form 1065 (Tax Year Ended December 31, 2021)

This memorandum is submitted on behalf of Ironside Capital Management LP ("ICM" or the "Fund") pursuant to the ongoing examination initiated by Letter 2205-D dated March 22, 2023. This submission supplements and consolidates the factual and legal positions set forth in ICM's prior responses to Information Document Requests ("IDRs") No. 1 through No. 4, and addresses matters discussed at the in-person meeting of July 14, 2023 at the IRS Manhattan Campus (290 Broadway, New York, NY 10007) and during the telephone conferences of June 9, 2023 and prior communications.

PRIVILEGE NOTICE: This memorandum supplements and does not supersede ICM's prior IDR responses and reserves all rights and privileges, including but not limited to attorney-client privilege, work product doctrine, and tax practitioner privilege under IRC § 7525. Nothing contained herein shall be construed as a waiver of any right, privilege, or defense available to ICM or any of its partners under applicable law. The legal analyses, arguments, and conclusions expressed herein reflect the positions of counsel and are protected by the work product doctrine. To the extent any communication described herein involves attorney-client communications, such communications are referenced solely to the extent necessary to present ICM's legal position and any privilege pertaining thereto is expressly preserved.

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I. INTRODUCTION AND EXECUTIVE SUMMARY

A. Purpose of This Memorandum

This memorandum constitutes a comprehensive legal position paper addressing all three issues raised by the examination team during the audit of Ironside Capital Management LP's 2021 federal partnership return (Form 1065). It is submitted to provide Revenue Agent Albrecht, IRS Counsel Lundgren, and the examination team with a unified legal analysis supported by applicable statutory authority, Treasury Regulations, legislative history, judicial precedent, and published IRS guidance. The purpose of this submission is to demonstrate, in a single integrated document, that each of the positions taken on ICM's 2021 Form 1065 is fully supported by applicable law and properly documented, and that no adjustment to the return is warranted on any of the three issues under examination.

This memorandum consolidates and builds upon the factual and legal positions previously presented by ICM in its responses to IDR #1 (submitted May 19, 2023), IDR #2 (submitted June 23, 2023), IDR #3 (submitted July 28, 2023), and IDR #4 (submitted August 18, 2023). It further addresses the specific questions and concerns raised by Revenue Agent Albrecht and IRS Counsel Lundgren at the July 14, 2023 in-person meeting at the IRS Manhattan Campus and during the telephone conference of June 9, 2023. To the extent that certain factual matters or documentation were addressed in prior IDR responses, this memorandum cross-references those submissions rather than reproducing the underlying documents in their entirety, although key documents are summarized and analyzed herein as necessary to support ICM's legal positions.

ICM has cooperated fully and in good faith with this examination from its inception. Across four IDR responses, ICM has produced approximately 4,600 pages of documents, including partnership agreements, board resolutions, trade confirmations, internal trade blotters, portfolio management system records, legal invoices, accounting workpapers, fund administration records, and tax return preparation workpapers. ICM has made its representatives, including its General Counsel and outside tax counsel, available for an in-person meeting and multiple telephone conferences. ICM submits this memorandum in the same spirit of cooperation and transparency, with the goal of providing the examination team with a thorough and well-documented record upon which to evaluate ICM's return positions and, respectfully, to close this examination without adjustment.

B. Identification of the Taxpayer

Ironside Capital Management LP ("ICM" or the "Fund") is a Delaware limited partnership formed on June 14, 2016. Its principal place of business and headquarters are located at 590 Madison Avenue, 28th Floor, New York, NY 10022. ICM's Employer Identification Number is 83-2741956. The Fund's registered agent is Capitol Statutory Services LLC, located at 1209 Orange Street, Wilmington, Delaware 19801.

ICM's general partner is Ironside Capital GP LLC ("GP" or the "General Partner"), a Delaware limited liability company with EIN 83-2741890. The GP was formed contemporaneously with the Fund in June 2016. The managing members of the GP are Desmond R. Calloway, who serves as the Fund's Founder and Chief Investment Officer and holds a 62% membership interest in the GP, and Priya Venkatesh, who serves as the Fund's Chief Operating Officer and Chief Financial Officer and holds a 28% membership interest in the GP. The remaining 10% of the GP's membership interests are held by other GP members who serve in senior investment and operational roles at the Fund.

ICM is a multi-strategy hedge fund employing a combination of global macro, event-driven equity, and credit strategies across both long and short positions in global equity, fixed income, credit, currency, and commodity markets. As of December 31, 2021, the Fund had assets under management ("AUM") of approximately $3.82 billion, with capital commitments from 47 limited partners in addition to the General Partner. The Fund's limited partners include a diverse group of institutional investors, including public pension funds, university endowments, family offices, foundations, and funds of funds.

ICM's 2021 Form 1065 was filed on September 15, 2022, pursuant to a valid extension. The return was prepared by Borwick Craine & Associates LLP, a nationally recognized public accounting firm, under the supervision of Elliot Navarro, CPA, who served as the engagement partner for tax services. The Fund's financial statements are prepared and its books and records maintained by Greystone Fund Administration LLC, a third-party fund administrator. Prime brokerage and custody services are provided by Ridgeline Securities LLC, a registered broker-dealer and member of FINRA.

C. Summary of Issues Under Examination

Revenue Agent Albrecht has identified three issues during the examination of ICM's 2021 Form 1065, as communicated in the IDRs and discussed during the in-person meeting of July 14, 2023 and the telephone conference of June 9, 2023. The three issues are as follows:

Issue 1 — Management Fee Waiver / Conversion. Whether $23.8 million of management fees waived by Ironside Capital GP LLC in exchange for an increased capital interest in the Fund constitutes a disguised payment for services under IRC § 707(a)(2)(A), warranting recharacterization of the waived amount as ordinary income to the GP. The IRS examination team has questioned whether this waiver arrangement effectively converted what should have been ordinary fee income (taxable at rates up to 37%) into long-term capital gain (taxable at 20%) through subsequent fund appreciation, resulting in an improper reduction in the GP's tax liability.

Issue 2 — Carried Interest Holding Period. Whether $38.7 million of the $94.3 million total performance allocation to the GP for the 2021 tax year qualifies for long-term capital gain treatment under IRC § 1061, specifically whether 14 positions liquidated in 2021 satisfied the three-year holding period requirement imposed by that section on gains attributable to applicable partnership interests held in connection with the performance of investment management services. The examination team has questioned the documentation of acquisition dates and holding periods for these 14 positions.

Issue 3 — Organizational and Syndication Cost Deductions. Whether $680,000 of the $1.42 million total deductions claimed under IRC § 709(b) on ICM's 2016 Form 1065 (with amortization deductions continuing through 2021) were properly classified as deductible organizational expenses, or whether some or all of such costs should instead be treated as non-deductible syndication costs under IRC § 709(a). The examination team has questioned the classification of certain legal, accounting, and advisory fees incurred in connection with ICM's formation in 2016.

D. Summary of ICM's Position

ICM respectfully submits that no adjustment is warranted on any of the three issues under examination. The positions taken on ICM's 2021 Form 1065 are fully supported by applicable statutory authority, Treasury Regulations, legislative history, judicial precedent, and published IRS guidance. The return positions are properly documented and substantiated by contemporaneous records, including partnership agreements, board resolutions, trade confirmations, fund administration records, legal invoices, and accounting workpapers.

The total potential partnership-level adjustment at issue across all three issues is approximately $63.18 million ($23.8 million + $38.7 million + $0.68 million). If sustained, the estimated total tax impact across all partners would be approximately $11.78 million, comprising approximately $4.95 million on Issue 1, approximately $6.579 million on Issue 2, and approximately $251,600 on Issue 3. ICM submits that none of these adjustments should be proposed, for the reasons set forth in detail in Sections II through IV of this memorandum.

As summarized briefly:

1. On Issue 1, the $23.8 million management fee waiver is a legitimate entrepreneurial risk arrangement in which the GP voluntarily and irrevocably converted a portion of its management fee entitlement into an at-risk capital interest in the Fund, bearing the same downside investment risk as all other limited partners. The waiver was elected prospectively on January 15, 2021, before any investment activity for the year, and was irrevocable once made. The arrangement satisfies all six factors of the disguised payment analysis under Treasury Regulation § 1.707-2 and was motivated by legitimate non-tax business purposes, including investor relations and alignment of interests.

2. On Issue 2, the $38.7 million in performance allocations at issue are properly treated as long-term capital gain under IRC § 1061. All 14 positions whose liquidation generated the gains at issue were held for in excess of three years prior to disposition, as fully documented by trade-level holding period analyses, Ridgeline Securities LLC trade confirmations, internal trade blotters, and fund administration records. The "One API Recharacterization Amount" under Treasury Regulation § 1.1061-4(a)(2) is zero.

3. On Issue 3, the $680,000 in challenged costs were properly classified as organizational expenses deductible under IRC § 709(b). These costs were incurred in connection with the creation of the partnership entity itself — including legal fees for drafting the partnership agreement, accounting fees for establishing the Fund's accounting systems, and state filing fees — and do not constitute syndication costs related to the issuance, marketing, or sale of partnership interests.

II. ISSUE 1 — MANAGEMENT FEE WAIVER UNDER IRC § 707(a)(2)(A)

A. Statement of the Issue

The first issue under examination is whether ICM's arrangement whereby Ironside Capital GP LLC waived $23.8 million of management fees for the 2021 tax year in exchange for an increased capital interest in the Fund constitutes a disguised payment for services under IRC § 707(a)(2)(A), warranting recharacterization of the waived amount as ordinary income to the GP.

The IRS examination team has questioned whether this management fee waiver effectively converted what should be ordinary fee income — taxable to the GP's members at ordinary income rates of up to 37% plus the 3.8% net investment income tax ("NIIT") under IRC § 1411 — into long-term capital gain taxable at the preferential rate of 20%, through the mechanism of subsequent fund appreciation on the GP's increased capital interest. If the IRS were to sustain the proposed adjustment, the potential tax impact to the GP and its members would be approximately $4.95 million, comprising approximately $4.046 million from the 17 percentage point rate differential between the 37% ordinary income rate and the 20% long-term capital gains rate applied to $23.8 million, plus approximately $904,000 from the 3.8% NIIT on the recharacterized amount (to the extent not already subject to NIIT as investment income allocated to the GP's capital account).

ICM submits that no recharacterization is warranted. The management fee waiver arrangement at issue satisfies the entrepreneurial risk standard under IRC § 707(a)(2)(A) and Treasury Regulation § 1.707-2, was motivated by legitimate non-tax business purposes, and is fully consistent with longstanding industry practice and applicable legal authority.

B. Factual Background

1. The Management Fee Structure

ICM's Amended and Restated Agreement of Limited Partnership, dated as of June 14, 2016, as amended through December 1, 2020 (the "LPA"), governs the economic arrangements among the partners. Section 4.1 of the LPA provides for an annual management fee equal to 2% of each limited partner's committed capital, payable quarterly in advance. This management fee structure is standard in the hedge fund industry and reflects the compensation payable to the GP and its affiliates for the ongoing investment management, administration, and operational services provided to the Fund.

For the 2021 tax year, the average committed capital of the Fund was approximately $3.58 billion. Accordingly, total management fees earned by the GP for 2021 were approximately $71.6 million ($3.58 billion × 2%).

2. The Fee Waiver Election Mechanism

Section 4.1(c) of the LPA provides the GP with an annual election to waive all or a portion of the management fees otherwise payable to it in exchange for an equivalent increase in its capital interest in the Fund. This provision was included in the original LPA at the time of the Fund's formation in 2016, at the request of several of the Fund's founding institutional investors, as a mechanism to align the GP's economic interests with those of the limited partners by increasing the GP's "skin in the game."

The fee waiver election under LPA Section 4.1(c) operates as follows:

(a) The GP may elect, on or before January 31 of each calendar year, to waive all or a specified portion of the management fees that would otherwise be payable to the GP for that calendar year.

(b) Any such election must be in writing, adopted by resolution of the managing members of the GP, and delivered to the Fund's administrator (Greystone Fund Administration LLC) prior to the commencement of the fee period to which the waiver relates.

(c) The waiver, once made, is irrevocable for the calendar year to which it relates. The GP may not subsequently reverse the waiver election and receive cash management fees for the waived portion.

(d) In consideration of the waiver, the GP receives an increase in its limited partner capital interest in the Fund equal to the dollar amount of the waived fees, as of the date the waived fees would otherwise have been payable. The increased capital interest is subject to the same terms, conditions, investment risk, lockup provisions, and withdrawal restrictions applicable to all other limited partner interests in the Fund.

(e) The GP's increased capital interest participates in all gains and losses of the Fund on the same basis and in the same proportion as all other limited partner capital interests, without any preferential allocation, priority of distribution, or downside protection.

3. The 2021 Fee Waiver Election

For the 2021 tax year, the GP elected to waive $23.8 million of its total $71.6 million management fee entitlement, representing approximately 33.2% of total management fees earned. The waiver election was adopted by written resolution of the managing members of Ironside Capital GP LLC on January 15, 2021 — sixteen days before the January 31 deadline and before the commencement of any significant investment activity for the year. A copy of the January 15, 2021 resolution was provided to the examination team as part of ICM's IDR #2 response dated June 23, 2023 (IDR #2, Bates Nos. ICM-002341 through ICM-002344).

The waiver was irrevocable once made. After January 15, 2021, the GP could not reverse the election and receive cash management fees for the $23.8 million waived amount, regardless of the Fund's subsequent investment performance.

The remaining $47.8 million of management fees ($71.6 million less $23.8 million) was paid to the GP in cash on a quarterly basis during 2021, and was reported as ordinary income on the GP's and its members' respective tax returns for 2021. There is no dispute regarding the tax treatment of the $47.8 million in cash management fees received by the GP.

4. Investment Risk on the Waived Amount

The $23.8 million of waived management fees was converted into a capital interest in the Fund that bore full investment risk — both upside and downside — identical to the investment risk borne by all other limited partners. The GP's increased capital interest was invested in the Fund's portfolio alongside all other partner capital, without any segregation, preferential allocation, priority of distribution, or downside protection. Had the Fund experienced negative investment performance in 2021, the value of the GP's increased capital interest would have declined proportionally, and the GP would have permanently forfeited the $23.8 million in cash management fees it otherwise would have received.

The Fund's multi-strategy investment approach — encompassing global macro, event-driven equity, and credit strategies — involves inherent and significant market risk, including the risk of loss of invested capital. The GP's capital interest was exposed to the full range of investment risks across all of the Fund's strategies and positions, including but not limited to market risk, credit risk, liquidity risk, counterparty risk, and geopolitical risk.

For the 2021 tax year, the Fund's gross investment return was approximately 18.7%. However, this result was unknown and unknowable at the time of the January 15, 2021 waiver election. At the time the GP made its irrevocable election, global financial markets were characterized by significant uncertainty, including ongoing concerns regarding the COVID-19 pandemic, inflation expectations, monetary policy normalization, and geopolitical tensions. The GP's decision to waive $23.8 million in cash fees and accept investment risk was a genuine entrepreneurial bet on the Fund's future performance.

5. The GP's Capital Accounts

As of December 31, 2021, the capital accounts of the GP's managing members reflected their substantial capital commitment to the Fund. Desmond R. Calloway's capital account balance was $187.4 million, and Priya Venkatesh's capital account balance was $48.6 million. These capital account balances include amounts attributable to prior-year fee waivers, performance allocations, and direct capital contributions, all of which bear the same investment risk as all other limited partner capital.

6. Third-Party Limited Partner Capital at Risk

The institutional limited partners of the Fund are sophisticated investors whose capital commitments are subject to the same investment risks as the GP's increased capital interest resulting from the fee waiver. Key limited partners include the Northgate Public Employees' Retirement System ($412 million commitment), the Marlowe Asset Management Horizon Endowment Fund ($175 million commitment), and Bramblewood Family Office LLC ($95 million commitment). All limited partner capital is subject to identical investment risk, lockup provisions, and withdrawal restrictions, without any preferential treatment or downside protection.

C. Applicable Legal Authority

1. IRC § 707(a)(2)(A) — Disguised Payments for Services

Section 707(a)(2)(A) of the Internal Revenue Code provides:

"If — (i) a partner performs services for a partnership or transfers property to a partnership, (ii) there is a related direct or indirect allocation and distribution to such partner, and (iii) the performance of such services (or such transfer) and the allocation and distribution, when viewed together, are properly characterized as a transaction occurring between the partnership and a partner acting other than in his capacity as a member of the partnership, such allocation and distribution shall be treated as a transaction described in paragraph (1) [i.e., as a transaction between the partnership and one who is not a partner]."

The purpose of § 707(a)(2)(A), as reflected in the legislative history, is to prevent partners from disguising what are in substance payments for services as partnership allocations in order to obtain preferential tax treatment. The statute operates by recharacterizing certain allocations and distributions as ordinary payments for services when the arrangement, viewed in its entirety, is more properly characterized as a fee-for-service transaction rather than a risk-sharing partnership arrangement.

However, the statute and the accompanying regulations recognize that not every arrangement in which a partner performs services and receives partnership allocations constitutes a disguised payment. The critical inquiry is whether the allocation and distribution are subject to significant entrepreneurial risk — that is, whether the partner is bearing genuine economic risk with respect to the amounts allocated, or whether the arrangement is structured to guarantee or substantially protect the partner against loss.

2. Treasury Regulation § 1.707-2 — Disguised Payments for Services

Treasury Regulation § 1.707-2(c) sets forth a six-factor test for determining whether an arrangement constitutes a disguised payment for services under § 707(a)(2)(A). The factors are:

(1) Whether the arrangement lacks significant entrepreneurial risk — that is, whether the allocation and distribution are subject to significant risk related to the overall success or failure of the partnership's business activities;

(2) Whether the partner's status as a partner is transient — for example, where the partner's interest is liquidated or substantially reduced after a short period;

(3) Whether the allocation and distribution relate to the partner's overall distributive share of partnership income — that is, whether the arrangement provides the partner with an allocation that is disproportionate to and independent of the partner's general interest in partnership profits;

(4) Whether the partner became a partner primarily to obtain tax benefits that would not have been available if the services had been rendered as a third party;

(5) Whether the value of the partner's interest in general and continuing partnership profits is small in relation to the allocation in question; and

(6) Whether the arrangement provides for distributions in a time frame comparable to the time frame that a non-partner service provider would be compensated — that is, whether the distribution is designed to occur shortly after the services are performed.

The regulations further provide that the most important factor in the analysis is whether the arrangement is subject to significant entrepreneurial risk. Treas. Reg. § 1.707-2(c)(1). Where the allocation and distribution are genuinely contingent on the overall success of the partnership's business and subject to a meaningful risk of loss, the arrangement is properly characterized as a partnership allocation rather than a disguised payment for services, even if the partner also performs services for the partnership.

3. Revenue Procedure 93-27

Revenue Procedure 93-27, 1993-2 C.B. 343, provides guidance on the tax consequences of a service provider's receipt of a partnership profits interest for services. The revenue procedure provides generally that the IRS will not treat the receipt of a profits interest for the provision of services to or for the benefit of a partnership as a taxable event for the partner or the partnership, provided certain conditions are met.

The fee waiver arrangement at issue in this examination is distinguishable from the situation addressed in Revenue Procedure 93-27. The GP is not receiving a new or additional profits interest for services; rather, the GP is voluntarily converting a portion of its contractual management fee entitlement into an at-risk capital interest in the Fund. The distinction is significant: in Revenue Procedure 93-27, the service provider receives an interest in future partnership profits that did not previously exist; in the present case, the GP is forgoing a cash fee to which it is contractually entitled and accepting instead a capital interest that bears genuine downside investment risk.

4. Relevant Case Law

Several judicial decisions inform the analysis of whether the management fee waiver at issue constitutes a disguised payment for services under § 707(a)(2)(A).

In Enterprise Mining Partners v. Commissioner, T.C. Memo. 2014-229, the Tax Court examined whether allocations to a partner performing services constituted disguised payments. The court applied the six-factor analysis of Treasury Regulation § 1.707-2 and emphasized that the determinative factor was whether the allocations were subject to significant entrepreneurial risk. The court held that allocations subject to genuine risk contingent upon the success of partnership operations were properly treated as partnership allocations rather than disguised payments.

In Canal Corp. v. Commissioner, 135 T.C. 199 (2010), the Tax Court addressed the distinction between partnership allocations and disguised payments in the context of complex partnership arrangements. The court reiterated that the fundamental inquiry is whether the economic substance of the arrangement reflects a genuine sharing of partnership risk or, instead, a transaction between the partnership and a person acting in a non-partner capacity.

In Pratt v. Commissioner, T.C. Memo. 2017-92, the Tax Court examined a profits interest arrangement and emphasized that genuine entrepreneurial risk — including the risk that the partner's interest could decline in value or become worthless — is the hallmark of a legitimate partnership allocation as distinguished from a disguised payment for services. The court noted that arrangements in which the partner's return is effectively guaranteed, protected from loss, or determined without regard to partnership performance are more properly characterized as disguised payments.

These decisions are consistent with ICM's position. The GP's management fee waiver bears genuine entrepreneurial risk: the GP irrevocably forfeited $23.8 million in cash management fees and accepted instead a capital interest that could have declined in value or been lost entirely if the Fund's investments performed poorly. The arrangement is the antithesis of a disguised payment: it is an at-risk investment of the GP's fee entitlement, subject to the same market risks borne by all other investors in the Fund.

By contrast, courts have recharacterized arrangements as disguised payments for services where the purported partnership allocation lacked genuine economic risk — for example, where the partner's return was effectively guaranteed through contractual protections, priority allocations, or retrospective election mechanisms. See, e.g., Gross v. Commissioner, T.C. Memo. 1999-254 (recharacterizing purported profit allocation as disguised payment where the partner's return was virtually certain and bore no meaningful risk of loss). The arrangement at issue here is fundamentally different: the GP assumed full investment risk on the waived amount, with no guarantee, floor, or priority of any kind.

5. IRS Guidance and Chief Counsel Advice

The IRS has addressed management fee waiver programs in the private fund context in various forms of published and internal guidance, although no formal regulatory project has been completed on this specific topic.

The IRS and Treasury Department included questions regarding management fee waiver arrangements on their Priority Guidance Plans for several years beginning in the early 2010s, signaling an awareness of these arrangements but ultimately declining to issue formal regulatory guidance specifically addressing them. The absence of affirmative regulatory action after years of consideration supports the conclusion that the IRS does not regard well-structured fee waiver arrangements — those bearing genuine entrepreneurial risk — as abusive or as per se disguised payments for services.

Chief Counsel Advice 200043014 addressed related issues in the context of partnership allocations to service partners and emphasized the importance of economic substance and entrepreneurial risk in the analysis. While this CCA did not specifically address management fee waivers, its analytical framework is consistent with the position that arrangements bearing genuine investment risk are properly characterized as partnership allocations.

Additionally, the IRS Large Business & International Division's Industry Director Directive on Partnership Issues, issued in connection with the Campaign on Carried Interest/Applicable Partnership Interests (announced in 2018), focused primarily on holding period compliance under IRC § 1061 rather than on fee waiver recharacterization under § 707(a)(2)(A). The absence of a specific IRS enforcement campaign targeting management fee waivers — despite the IRS's awareness of these arrangements — further supports the conclusion that properly structured fee waivers are not improper.

D. Analysis — The $23.8M Fee Waiver Satisfies the Entrepreneurial Risk Standard

1. Genuine Downside Exposure

The most important factor in the § 707(a)(2)(A) analysis is whether the allocation and distribution are subject to significant entrepreneurial risk. Treas. Reg. § 1.707-2(c)(1). Here, the GP's waived management fees were converted into a capital interest in the Fund that bore the full range of investment risk — including the risk of complete loss — identical to the risk borne by every other limited partner in the Fund.

In exchange for waiving $23.8 million in cash management fees, the GP received an increased capital interest in the Fund. That capital interest was invested in the Fund's portfolio on the same terms and conditions as all other partner capital, without any segregation, preferential allocation, priority of distribution, guaranteed return, loss protection, or other mechanism that would reduce or eliminate the GP's investment risk. The GP's increased capital interest participated in all gains and losses of the Fund's investment portfolio on a pari passu basis with all other limited partner interests.

If the Fund had experienced negative investment performance in 2021, the GP's increased capital interest would have declined in value in direct proportion to the Fund's losses. In a severe drawdown scenario, the GP could have lost a substantial portion — or even all — of the $23.8 million in waived fees. The GP would have received no cash management fees for the waived amount and would have suffered an investment loss on its capital interest, resulting in a permanent economic loss.

The significance of this downside exposure cannot be overstated. The GP did not merely defer receipt of its management fees; it permanently forfeited its right to receive $23.8 million in cash and accepted in exchange an investment position subject to material and uncontrollable market risk. This is the very essence of entrepreneurial risk as contemplated by the regulations.

Moreover, the Fund's investment strategies — global macro, event-driven equity, and credit — are inherently volatile and subject to substantial risk. The Fund employs leverage and takes both long and short positions across multiple asset classes and geographies, exposing the GP's capital interest to a wide range of market risks, including equity market risk, interest rate risk, credit risk, currency risk, commodity risk, liquidity risk, and geopolitical risk. The GP's decision to accept investment risk in lieu of cash fees was a genuine entrepreneurial decision, not a risk-free conversion of ordinary income to capital gain.

2. Timing and Irrevocability of the Election

The timing and irrevocability of the fee waiver election are critical factors supporting the conclusion that the arrangement bears genuine entrepreneurial risk.

The GP's waiver election was made on January 15, 2021, before the commencement of any significant investment activity for the 2021 tax year. At the time of the election, the Fund's 2021 investment performance was entirely unknown. The GP could not have known, at the time it made its irrevocable election, whether the Fund would generate positive or negative returns during 2021. The election was a prospective bet on the Fund's future performance, made under conditions of genuine uncertainty.

The irrevocability of the election is equally significant. Under LPA Section 4.1(c), the waiver election, once made, could not be reversed for the calendar year to which it related. The GP could not observe the Fund's investment performance during 2021 and then decide, after the fact, whether to waive its management fees. This distinguishes the ICM arrangement from the type of abusive "look-back" or "hindsight" fee waiver structure that the IRS has appropriately challenged — i.e., arrangements in which the manager effectively retains the option to waive fees only after ascertaining that the Fund's investment performance has been favorable, thereby eliminating any meaningful downside risk.

The prospective and irrevocable character of the GP's election is fully documented. The January 15, 2021 resolution of the managing members of the GP was executed by Desmond R. Calloway and Priya Venkatesh, delivered to Greystone Fund Administration LLC (the Fund's administrator), and recorded in the Fund's books and records. A copy of the resolution was provided to the examination team as part of ICM's IDR #2 response (IDR #2, Bates Nos. ICM-002341 through ICM-002344).

3. Application of Treasury Regulation § 1.707-2 Six-Factor Test

A systematic application of the six factors set forth in Treasury Regulation § 1.707-2(c) demonstrates that all six factors weigh in favor of characterizing the management fee waiver as a legitimate partnership allocation rather than a disguised payment for services.

Factor 1: Significant Entrepreneurial Risk. As detailed above, the GP's waived management fees were converted into a capital interest bearing full investment risk identical to that of third-party limited partners. The GP was exposed to the full downside of the Fund's investment performance, including the risk of complete loss of the waived amount. This factor weighs strongly in favor of treatment as a legitimate partnership allocation.

Factor 2: Transient Partner Status. This factor examines whether the partner's status is transient — that is, whether the partner's interest is liquidated or substantially reduced shortly after the arrangement takes effect. Here, Ironside Capital GP LLC has been the general partner of the Fund since its formation in June 2016, a period of more than five years as of the date of the 2021 fee waiver election. The GP's partnership interest is not transient; it is permanent and ongoing. The GP's increased capital interest resulting from the fee waiver is subject to the same lockup and withdrawal restrictions applicable to all limited partner interests, and no liquidation, redemption, or distribution of the GP's increased capital interest occurred in 2021 or was planned at the time of the election. This factor weighs strongly in favor of treatment as a legitimate partnership allocation.

Factor 3: Relationship to Overall Distributive Share. This factor examines whether the arrangement provides the partner with an allocation that is disproportionate to and independent of the partner's overall interest in partnership profits. The GP's capital interest resulting from the fee waiver is not disproportionate or independent; it is a component of the GP's overall economic interest in the Fund and participates in gains and losses on the same basis as all other limited partner capital. The $23.8 million waiver amount represents approximately 33.2% of the GP's total management fee entitlement and is consistent with the GP's overall economic arrangement with the Fund. The waiver does not create a special or preferential allocation; it increases the GP's capital interest in the Fund on terms identical to those of other investors. This factor weighs in favor of treatment as a legitimate partnership allocation.

Factor 4: Tax Benefit Motive. This factor examines whether the partner became a partner primarily to obtain tax benefits that would not have been available if the services had been rendered as a third party. The GP has been the general partner of the Fund since its formation and serves as the Fund's investment manager and operator. The GP did not become a partner primarily to obtain tax benefits; it is the founder and manager of the Fund and would be a partner regardless of any fee waiver arrangement. Moreover, the fee waiver program was established for legitimate non-tax business purposes, including alignment of the GP's interests with those of the limited partners and compliance with investor demands for "co-investment" and "skin in the game" arrangements. This factor weighs in favor of treatment as a legitimate partnership allocation.

Factor 5: Relative Size of Allocation. This factor examines whether the value of the partner's interest in general and continuing partnership profits is small in relation to the allocation at issue. Here, the GP's overall economic interest in the Fund is substantial. The GP is entitled to a 20% carried interest (performance allocation) and a 2% management fee, and the GP's capital account as of December 31, 2021 reflects combined capital of $187.4 million (Mr. Calloway) and $48.6 million (Ms. Venkatesh), plus additional amounts attributable to other GP members. The $23.8 million waiver amount is modest relative to the Fund's total AUM of $3.82 billion and the GP's overall economic interest. This factor weighs in favor of treatment as a legitimate partnership allocation.

Factor 6: Short-Period Distribution. This factor examines whether the arrangement provides for distributions in a time frame comparable to that in which a non-partner service provider would be compensated — that is, whether the distribution is designed to occur shortly after the services are performed. Here, the GP's increased capital interest is not subject to any near-term distribution. The capital interest is subject to the same lockup and withdrawal restrictions applicable to all limited partner interests, which include a one-year initial lockup period and quarterly withdrawal rights thereafter with 90 days' notice, subject to restrictions during periods of market stress. No distribution of the GP's increased capital interest was made in 2021 or was planned at the time of the election. This factor weighs in favor of treatment as a legitimate partnership allocation.

In sum, all six factors of the Treasury Regulation § 1.707-2(c) test weigh in favor of treating the management fee waiver as a legitimate partnership allocation rather than a disguised payment for services. The most important factor — significant entrepreneurial risk — is satisfied emphatically, as the GP bears full investment risk on the waived amount with no guarantee, floor, or downside protection of any kind.

4. Business Purpose and Investor Relations Rationale

The management fee waiver program was established at the time of the Fund's formation in 2016 for legitimate non-tax business purposes, and the 2021 fee waiver election was made for the same reasons.

First, the fee waiver program serves to align the GP's economic interests with those of the limited partners. By converting a portion of its cash management fees into an at-risk capital interest, the GP demonstrates its confidence in the Fund's investment strategy and signals to limited partners that the GP's economic interests are aligned with theirs. This alignment of interests is a core principle of institutional fund management and is widely regarded as a best practice in the alternative investment industry.

Second, the fee waiver program was established at the specific request of several of the Fund's founding institutional investors. The Northgate Public Employees' Retirement System, which committed $412 million to the Fund, and the Marlowe Asset Management Horizon Endowment Fund, which committed $175 million, both specifically requested that the Fund's LPA include a fee waiver mechanism as a condition of their capital commitments. These investors view the GP's willingness to accept investment risk in lieu of cash fees as evidence of the GP's conviction in the Fund's strategy and as a meaningful alignment mechanism that benefits all limited partners.

Third, the fee waiver arrangement was fully disclosed to all limited partners and described in the Fund's offering documents, including the Confidential Private Placement Memorandum dated June 2016 (as supplemented) and the LPA. All limited partners were aware of and consented to the arrangement as part of their subscription to the Fund.

Fourth, the fee waiver arrangement is a well-established and widely used practice in the hedge fund and private equity industry. Management fee waiver programs are employed by many of the largest and most reputable fund managers, and are recognized by institutional investors, industry associations, and market participants as a legitimate mechanism for aligning the interests of fund managers and investors. The ICM arrangement is consistent with industry norms and standards.

E. Conclusion on Issue 1

For all of the foregoing reasons, the $23.8 million management fee waiver does not constitute a disguised payment for services under IRC § 707(a)(2)(A). The waiver bears genuine entrepreneurial risk, was elected prospectively and irrevocably before the commencement of the fee period, converts the GP's fee entitlement into an at-risk capital interest bearing full investment risk identical to that of third-party limited partners, satisfies all six factors of the disguised payment analysis under Treasury Regulation § 1.707-2(c), and was motivated by legitimate non-tax business purposes. The arrangement is fully consistent with the statutory and regulatory framework, judicial precedent, and published IRS guidance. No adjustment is warranted on Issue 1.

III. ISSUE 2 — CARRIED INTEREST HOLDING PERIOD UNDER IRC § 1061

A. Statement of the Issue

The second issue under examination is whether $38.7 million of the $94.3 million total performance allocation to the GP for the 2021 tax year qualifies for long-term capital gain treatment under IRC § 1061.

Section 1061 of the Internal Revenue Code, enacted by the Tax Cuts and Jobs Act of 2017, extends the holding period requirement for long-term capital gain treatment of income attributable to "applicable partnership interests" — commonly known as "carried interest" — from one year to three years. Under § 1061(a), net long-term capital gain with respect to an applicable partnership interest is treated as short-term capital gain (and taxed at ordinary income rates of up to 37%) to the extent the gain is attributable to partnership assets held for three years or less.

The IRS examination team has questioned whether 14 specific positions liquidated by the Fund in 2021, whose gains are included in the $38.7 million at issue, satisfied the three-year holding period requirement of § 1061(a). If the IRS were to sustain the proposed adjustment, the potential tax impact to the GP and its members would be approximately $6.579 million, representing the 17 percentage point rate differential between the 37% short-term capital gain rate and the 20% long-term capital gain rate applied to $38.7 million.

ICM submits that all 14 positions at issue were held for in excess of three years prior to their disposition in 2021, and that the $38.7 million in performance allocations is properly treated as long-term capital gain under § 1061. The holding periods are fully documented by trade-level records from the Fund's prime broker, internal portfolio management systems, fund administration records, and tax return preparation workpapers.

B. Factual Background

1. The Performance Allocation Structure

Section 5.2 of the LPA provides for a performance allocation (commonly referred to as "carried interest") equal to 20% of each limited partner's net profits for each fiscal year, above an 8% annualized preferred return hurdle with a full catch-up provision. The performance allocation is structured as a special allocation of partnership income (including capital gains) to the GP, rather than as a fee payable by the Fund.

For the 2021 tax year, total performance allocations to the GP were $94.3 million, reflecting the Fund's gross investment return of approximately 18.7% and the application of the 20% carried interest above the 8% preferred return hurdle. Of this $94.3 million, $55.6 million is attributable to gains on assets held for more than three years that are not in dispute, and $38.7 million is the amount at issue, attributable to gains on the 14 specific positions questioned by the examination team.

2. The 14 Challenged Positions

The IRS has identified 14 positions whose liquidation during 2021 generated gains included in the $38.7 million at issue. These positions span the Fund's global macro, event-driven equity, and credit strategies and include equity securities, corporate bonds, sovereign debt instruments, and structured credit positions. All 14 positions were acquired by the Fund through arm's-length market transactions executed through Ridgeline Securities LLC, the Fund's prime broker.

A detailed trade-level holding period analysis for each of the 14 positions was provided to the examination team as part of ICM's IDR #3 response dated July 28, 2023 (IDR #3, Bates Nos. ICM-003512 through ICM-003688). That analysis was prepared by Robert Jansen, an associate in the Tax Department of Calderwood & Harkness LLP, under the supervision of the undersigned, and was based on trade confirmations from Ridgeline Securities LLC, internal trade blotters maintained by ICM's portfolio management team, portfolio management system records, and Borwick Craine & Associates LLP tax return preparation workpapers.

The holding period schedule submitted with the IDR #3 response contains, for each of the 14 positions, the following information:

• Position identifier and security/instrument name

• Acquisition date(s) and method of acquisition

• Disposition date(s) and method of disposition

• Holding period in calendar days and years

• Acquisition cost (tax basis)

• Sale proceeds

• Gain or loss amount

• Long-term versus short-term capital gain classification

• Cross-reference to Ridgeline Securities LLC trade confirmation number(s)

All 14 positions reflected in the holding period schedule show a holding period exceeding 1,095 days (three years), with the shortest holding period among the 14 positions being well in excess of three years. The total gains attributable to these 14 positions aggregate to the $38.7 million at issue.

3. Corroborating Documentation

The holding periods for the 14 challenged positions are corroborated by multiple independent sources of documentation:

Ridgeline Securities LLC Trade Confirmations. For each of the 14 positions, Ridgeline Securities LLC issued trade confirmations at the time of acquisition and at the time of disposition. The trade confirmations specify the trade date, settlement date, security description, quantity, price, and counterparty for each transaction. Copies of all relevant trade confirmations were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003689 through ICM-003842).

Internal Trade Blotters and Portfolio Management System Records. ICM maintains contemporaneous internal trade blotters and portfolio management system records that document all trades executed on behalf of the Fund. These records were generated by ICM's order management system at the time each trade was executed and were maintained in the ordinary course of business. The trade blotters confirm the acquisition and disposition dates for each of the 14 positions. Relevant excerpts were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003843 through ICM-003901).

Borwick Craine & Associates LLP Workpapers. Borwick Craine & Associates LLP, the Fund's independent public accounting firm, prepared workpapers in connection with the preparation of ICM's 2021 Form 1065 that reconcile the reported gains on the 14 positions to the Fund's books and records. These workpapers were prepared under the supervision of Elliot Navarro, CPA, engagement partner for tax, and confirm the acquisition dates, disposition dates, holding periods, and gain amounts for each of the 14 positions. The workpapers were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003902 through ICM-003958).

Greystone Fund Administration LLC NAV Calculations. Greystone Fund Administration LLC, the Fund's independent third-party administrator, performs net asset value ("NAV") calculations for the Fund on a daily basis. The NAV calculations confirm the performance allocation amounts for 2021, including the amounts attributable to the 14 positions at issue. Relevant excerpts of the NAV calculations were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003959 through ICM-004012).

C. Applicable Legal Authority

1. IRC § 1061 — Partnership Interests Held in Connection with Performance of Services

Section 1061 was enacted as part of the Tax Cuts and Jobs Act of 2017, P.L. 115-97, § 13309, effective for taxable years beginning after December 31, 2017. The provision was adopted in response to longstanding policy concerns regarding the taxation of carried interest income at preferential long-term capital gain rates.

Section 1061(a) provides:

"If one or more applicable partnership interests are held by a taxpayer at any time during the taxable year, the excess (if any) of — (A) the taxpayer's net long-term capital gain with respect to such interests for such taxable year, over (B) the taxpayer's net long-term capital gain with respect to such interests for such taxable year computed by applying paragraphs (3) and (4) of section 1222 by substituting '3 years' for '1 year', shall be treated as short-term capital gain, notwithstanding section 83 or any election in effect under section 83(b)."

In other words, § 1061(a) requires that gains attributable to applicable partnership interests be held for more than three years (rather than the standard one year) in order to qualify for long-term capital gain treatment. Gains attributable to assets held for three years or less are recharacterized as short-term capital gain and taxed at ordinary income rates.

Section 1061(c)(1) defines an "applicable partnership interest" as "any interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any applicable trade or business." Section 1061(c)(2) defines an "applicable trade or business" to include, among other things, any activity conducted on a regular, continuous, and substantial basis which consists, in whole or in part, of "raising or returning capital, and either — (i) investing in (or disposing of) specified assets (or identifying specified assets for such investing or disposition), or (ii) developing specified assets."

2. Treasury Regulation §§ 1.1061-1 through 1.1061-6

The Treasury Department and the IRS issued final regulations under § 1061 on January 7, 2021 (T.D. 9945, 86 Fed. Reg. 5,454), effective for tax years beginning after December 31, 2017. These regulations provide comprehensive guidance on the application of § 1061, including the determination of the three-year holding period.

Treasury Regulation § 1.1061-4 sets forth the rules for calculating the recharacterization amount under § 1061(a). Under Treas. Reg. § 1.1061-4(a)(1), the amount recharacterized as short-term capital gain is the "API One Year Distributive Share Amount" minus the "API Three Year Distributive Share Amount." The API Three Year Distributive Share Amount includes only items of long-term capital gain and loss that would be treated as long-term capital gain or loss if a three-year holding period were substituted for the standard one-year holding period.

Critically, the holding period is measured at the asset level — that is, the holding period of the underlying partnership assets, not the holding period of the partner's interest in the partnership. Treas. Reg. § 1.1061-4(b)(7). This asset-level measurement ensures that the three-year holding period requirement is applied based on the actual holding period of the investments generating the gains, regardless of when the partner acquired or transferred its partnership interest.

The regulations also permit aggregation and netting within the holding period determination, as provided in Treas. Reg. § 1.1061-4(a)(3), and provide specific rules for tiered partnership structures, lookthrough computations, and transfers of applicable partnership interests.

3. Legislative History

The Conference Report to the Tax Cuts and Jobs Act, H.R. Rep. No. 115-466, at 433-34 (2017), confirms that the purpose of § 1061 is to require fund managers receiving carried interest allocations to hold the underlying investments for more than three years in order to obtain long-term capital gain treatment. The Conference Report states:

"Under the provision, if one or more applicable partnership interests are held by a taxpayer at any time during the taxable year, the excess (if any) of the taxpayer's net long-term capital gain with respect to such interests for such taxable year, over the taxpayer's net long-term capital gain with respect to such interests for such taxable year computed by applying a three-year (rather than a one-year) holding period, is treated as short-term capital gain."

The legislative history further confirms that § 1061 is intended to apply to carried interest allocations in the context of asset management, including hedge funds, private equity funds, and real estate funds, and is not intended to alter the fundamental partnership taxation framework or to apply to capital interests acquired by partners through capital contributions.

D. Analysis — All 14 Positions Satisfy the Three-Year Holding Period

1. Trade-Level Evidence

The holding period analysis submitted with ICM's IDR #3 response on July 28, 2023 provides trade-level evidence establishing that all 14 positions at issue were held by the Fund for in excess of three years (1,095 days) prior to their disposition in 2021. The analysis was prepared by Robert Jansen of Calderwood & Harkness LLP based on Ridgeline Securities LLC trade confirmations, internal trade blotters, portfolio management system records, and Borwick Craine & Associates LLP tax return preparation workpapers.

The holding period schedule (an Excel workbook containing detailed position-by-position data) demonstrates that the acquisition dates for all 14 positions fall on or before the relevant dates in 2018 that would be necessary to satisfy a three-year holding period for dispositions occurring in 2021. The specific acquisition dates, disposition dates, and holding periods for each position are set forth in the schedule, with each position showing a holding period that exceeds 1,095 days by a substantial margin.

The total gains attributable to the 14 positions aggregate to $38.7 million, all of which qualifies for long-term capital gain treatment under the three-year holding period rule of § 1061(a).

2. Corroborating Documentation

As described in Section III.B.3 above, the holding periods for the 14 positions are corroborated by four independent sources of documentation: (i) Ridgeline Securities LLC trade confirmations, which provide contemporaneous, third-party evidence of the trade dates for each acquisition and disposition; (ii) ICM's internal trade blotters and portfolio management system records, which were generated in the ordinary course of business at the time each trade was executed; (iii) Borwick Craine & Associates LLP workpapers, which reconcile the reported gains to the Fund's books and records; and (iv) Greystone Fund Administration LLC NAV calculations, which confirm the performance allocation amounts.

The consistency of the holding period data across these four independent sources provides strong corroborative evidence that the acquisition dates and holding periods reported on ICM's 2021 Form 1065 are accurate. There are no discrepancies between the trade confirmations, internal records, accounting workpapers, and fund administration records with respect to the acquisition or disposition dates for any of the 14 positions.

3. Application of Treasury Regulation § 1.1061-4

ICM's GP holds an "applicable partnership interest" within the meaning of IRC § 1061(c)(1), as the GP's interest in the Fund is held in connection with the performance of substantial services by the GP and its members in an applicable trade or business (investment management). Accordingly, the three-year holding period requirement of § 1061(a) applies to gains allocable to the GP's carried interest.

However, because all of the gains at issue — the $38.7 million attributable to the 14 challenged positions — are attributable to assets held by the Fund for more than three years, no recharacterization under § 1061(a) is required. Applying the framework of Treasury Regulation § 1.1061-4(a):

(a) The "API One Year Distributive Share Amount" includes the $38.7 million in gains, as all 14 positions were held for more than one year.

(b) The "API Three Year Distributive Share Amount" also includes the $38.7 million in gains, as all 14 positions were held for more than three years.

(c) The "One API Recharacterization Amount" — calculated as the API One Year Distributive Share Amount minus the API Three Year Distributive Share Amount — is therefore zero with respect to these 14 positions.

Because the One API Recharacterization Amount is zero, no portion of the $38.7 million in gains is recharacterized as short-term capital gain under § 1061(a), and the full amount is properly treated as long-term capital gain taxable at the 20% rate.

4. Responses to Specific IRS Questions from July 14, 2023 Meeting

At the in-person meeting held on July 14, 2023 at the IRS Manhattan Campus (290 Broadway, New York, NY 10007), IRS Counsel Eric S. Lundgren raised several specific questions regarding the documentation of acquisition dates for certain of the 14 positions. ICM addresses each of those questions below.

Question regarding complex or structured positions. Mr. Lundgren asked whether an

LEGAL MEMORANDUM OF IRONSIDE CAPITAL MANAGEMENT LP IN SUPPORT OF POSITIONS TAKEN ON 2021 PARTNERSHIP RETURN (FORM 1065)
September 6, 2023
FROM:
Sylvia Hartwell, Partner Calderwood & Harkness LLP 1251 Avenue of the Americas, 40th Floor New York, NY 10020 Telephone: (212) 558-4000 Facsimile: (212) 558-3588
Email: shartwell@calderwoodharkness.com
TO:
Timothy J. Albrecht Revenue Agent (Badge No. 74-28193) IRS Large Business & International Division 290 Broadway New York, NY 10007
Eric S. Lundgren Attorney, IRS Office of Chief Counsel Large Business & International Branch 5 290 Broadway New York, NY 10007
RE: Ironside Capital Management LP (EIN 83-2741956) — Examination of 2021 Form 1065 (Tax Year Ended December 31, 2021)
This memorandum is submitted on behalf of Ironside Capital Management LP ("ICM" or the "Fund") pursuant to the ongoing examination initiated by Letter 2205-D dated March 22, 2023. This submission supplements and consolidates the factual and legal positions set forth in ICM's prior responses to Information Document Requests ("IDRs") No. 1 through No. 4, and addresses matters discussed at the in-person meeting of July 14, 2023 at the IRS Manhattan Campus (290 Broadway, New York, NY 10007) and during the telephone conferences of June 9, 2023 and prior communications.
PRIVILEGE NOTICE: This memorandum supplements and does not supersede ICM's prior IDR responses and reserves all rights and privileges, including but not limited to attorney-client privilege, work product doctrine, and tax practitioner privilege under IRC § 7525. Nothing contained herein shall be construed as a waiver of any right, privilege, or defense available to ICM or any of its partners under applicable law. The legal analyses, arguments, and conclusions expressed herein reflect the positions of counsel and are protected by the work product doctrine. To the extent any communication described herein involves attorney-client communications, such communications are referenced solely to the extent necessary to present ICM's legal position and any privilege pertaining thereto is expressly preserved.
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I. INTRODUCTION AND EXECUTIVE SUMMARY
A. Purpose of This Memorandum
This memorandum constitutes a comprehensive legal position paper addressing all three issues raised by the examination team during the audit of Ironside Capital Management LP's 2021 federal partnership return (Form 1065). It is submitted to provide Revenue Agent Albrecht, IRS Counsel Lundgren, and the examination team with a unified legal analysis supported by applicable statutory authority, Treasury Regulations, legislative history, judicial precedent, and published IRS guidance. The purpose of this submission is to demonstrate, in a single integrated document, that each of the positions taken on ICM's 2021 Form 1065 is fully supported by applicable law and properly documented, and that no adjustment to the return is warranted on any of the three issues under examination.
This memorandum consolidates and builds upon the factual and legal positions previously presented by ICM in its responses to IDR #1 (submitted May 19, 2023), IDR #2 (submitted June 23, 2023), IDR #3 (submitted July 28, 2023), and IDR #4 (submitted August 18, 2023). It further addresses the specific questions and concerns raised by Revenue Agent Albrecht and IRS Counsel Lundgren at the July 14, 2023 in-person meeting at the IRS Manhattan Campus and during the telephone conference of June 9, 2023. To the extent that certain factual matters or documentation were addressed in prior IDR responses, this memorandum cross-references those submissions rather than reproducing the underlying documents in their entirety, although key documents are summarized and analyzed herein as necessary to support ICM's legal positions.
ICM has cooperated fully and in good faith with this examination from its inception. Across four IDR responses, ICM has produced approximately 4,600 pages of documents, including partnership agreements, board resolutions, trade confirmations, internal trade blotters, portfolio management system records, legal invoices, accounting workpapers, fund administration records, and tax return preparation workpapers. ICM has made its representatives, including its General Counsel and outside tax counsel, available for an in-person meeting and multiple telephone conferences. ICM submits this memorandum in the same spirit of cooperation and transparency, with the goal of providing the examination team with a thorough and well-documented record upon which to evaluate ICM's return positions and, respectfully, to close this examination without adjustment.
B. Identification of the Taxpayer
Ironside Capital Management LP ("ICM" or the "Fund") is a Delaware limited partnership formed on June 14, 2016. Its principal place of business and headquarters are located at 590 Madison Avenue, 28th Floor, New York, NY 10022. ICM's Employer Identification Number is 83-2741956. The Fund's registered agent is Capitol Statutory Services LLC, located at 1209 Orange Street, Wilmington, Delaware 19801.
ICM's general partner is Ironside Capital GP LLC ("GP" or the "General Partner"), a Delaware limited liability company with EIN 83-2741890. The GP was formed contemporaneously with the Fund in June 2016. The managing members of the GP are Desmond R. Calloway, who serves as the Fund's Founder and Chief Investment Officer and holds a 62% membership interest in the GP, and Priya Venkatesh, who serves as the Fund's Chief Operating Officer and Chief Financial Officer and holds a 28% membership interest in the GP. The remaining 10% of the GP's membership interests are held by other GP members who serve in senior investment and operational roles at the Fund.
ICM is a multi-strategy hedge fund employing a combination of global macro, event-driven equity, and credit strategies across both long and short positions in global equity, fixed income, credit, currency, and commodity markets. As of December 31, 2021, the Fund had assets under management ("AUM") of approximately $3.82 billion, with capital commitments from 47 limited partners in addition to the General Partner. The Fund's limited partners include a diverse group of institutional investors, including public pension funds, university endowments, family offices, foundations, and funds of funds.
ICM's 2021 Form 1065 was filed on September 15, 2022, pursuant to a valid extension. The return was prepared by Borwick Craine & Associates LLP, a nationally recognized public accounting firm, under the supervision of Elliot Navarro, CPA, who served as the engagement partner for tax services. The Fund's financial statements are prepared and its books and records maintained by Greystone Fund Administration LLC, a third-party fund administrator. Prime brokerage and custody services are provided by Ridgeline Securities LLC, a registered broker-dealer and member of FINRA.
C. Summary of Issues Under Examination
Revenue Agent Albrecht has identified three issues during the examination of ICM's 2021 Form 1065, as communicated in the IDRs and discussed during the in-person meeting of July 14, 2023 and the telephone conference of June 9, 2023. The three issues are as follows:
Issue 1 — Management Fee Waiver / Conversion. Whether $23.8 million of management fees waived by Ironside Capital GP LLC in exchange for an increased capital interest in the Fund constitutes a disguised payment for services under IRC § 707(a)(2)(A), warranting recharacterization of the waived amount as ordinary income to the GP. The IRS examination team has questioned whether this waiver arrangement effectively converted what should have been ordinary fee income (taxable at rates up to 37%) into long-term capital gain (taxable at 20%) through subsequent fund appreciation, resulting in an improper reduction in the GP's tax liability.
Issue 2 — Carried Interest Holding Period. Whether $38.7 million of the $94.3 million total performance allocation to the GP for the 2021 tax year qualifies for long-term capital gain treatment under IRC § 1061, specifically whether 14 positions liquidated in 2021 satisfied the three-year holding period requirement imposed by that section on gains attributable to applicable partnership interests held in connection with the performance of investment management services. The examination team has questioned the documentation of acquisition dates and holding periods for these 14 positions.
Issue 3 — Organizational and Syndication Cost Deductions. Whether $680,000 of the $1.42 million total deductions claimed under IRC § 709(b) on ICM's 2016 Form 1065 (with amortization deductions continuing through 2021) were properly classified as deductible organizational expenses, or whether some or all of such costs should instead be treated as non-deductible syndication costs under IRC § 709(a). The examination team has questioned the classification of certain legal, accounting, and advisory fees incurred in connection with ICM's formation in 2016.
D. Summary of ICM's Position
ICM respectfully submits that no adjustment is warranted on any of the three issues under examination. The positions taken on ICM's 2021 Form 1065 are fully supported by applicable statutory authority, Treasury Regulations, legislative history, judicial precedent, and published IRS guidance. The return positions are properly documented and substantiated by contemporaneous records, including partnership agreements, board resolutions, trade confirmations, fund administration records, legal invoices, and accounting workpapers.
The total potential partnership-level adjustment at issue across all three issues is approximately $63.18 million ($23.8 million + $38.7 million + $0.68 million). If sustained, the estimated total tax impact across all partners would be approximately $11.78 million, comprising approximately $4.95 million on Issue 1, approximately $6.579 million on Issue 2, and approximately $251,600 on Issue 3. ICM submits that none of these adjustments should be proposed, for the reasons set forth in detail in Sections II through IV of this memorandum.
As summarized briefly:
1. On Issue 1, the $23.8 million management fee waiver is a legitimate entrepreneurial risk arrangement in which the GP voluntarily and irrevocably converted a portion of its management fee entitlement into an at-risk capital interest in the Fund, bearing the same downside investment risk as all other limited partners. The waiver was elected prospectively on January 15, 2021, before any investment activity for the year, and was irrevocable once made. The arrangement satisfies all six factors of the disguised payment analysis under Treasury Regulation § 1.707-2 and was motivated by legitimate non-tax business purposes, including investor relations and alignment of interests.
2. On Issue 2, the $38.7 million in performance allocations at issue are properly treated as long-term capital gain under IRC § 1061. All 14 positions whose liquidation generated the gains at issue were held for in excess of three years prior to disposition, as fully documented by trade-level holding period analyses, Ridgeline Securities LLC trade confirmations, internal trade blotters, and fund administration records. The "One API Recharacterization Amount" under Treasury Regulation § 1.1061-4(a)(2) is zero.
3. On Issue 3, the $680,000 in challenged costs were properly classified as organizational expenses deductible under IRC § 709(b). These costs were incurred in connection with the creation of the partnership entity itself — including legal fees for drafting the partnership agreement, accounting fees for establishing the Fund's accounting systems, and state filing fees — and do not constitute syndication costs related to the issuance, marketing, or sale of partnership interests.
II. ISSUE 1 — MANAGEMENT FEE WAIVER UNDER IRC § 707(a)(2)(A)
A. Statement of the Issue
The first issue under examination is whether ICM's arrangement whereby Ironside Capital GP LLC waived $23.8 million of management fees for the 2021 tax year in exchange for an increased capital interest in the Fund constitutes a disguised payment for services under IRC § 707(a)(2)(A), warranting recharacterization of the waived amount as ordinary income to the GP.
The IRS examination team has questioned whether this management fee waiver effectively converted what should be ordinary fee income — taxable to the GP's members at ordinary income rates of up to 37% plus the 3.8% net investment income tax ("NIIT") under IRC § 1411 — into long-term capital gain taxable at the preferential rate of 20%, through the mechanism of subsequent fund appreciation on the GP's increased capital interest. If the IRS were to sustain the proposed adjustment, the potential tax impact to the GP and its members would be approximately $4.95 million, comprising approximately $4.046 million from the 17 percentage point rate differential between the 37% ordinary income rate and the 20% long-term capital gains rate applied to $23.8 million, plus approximately $904,000 from the 3.8% NIIT on the recharacterized amount (to the extent not already subject to NIIT as investment income allocated to the GP's capital account).
ICM submits that no recharacterization is warranted. The management fee waiver arrangement at issue satisfies the entrepreneurial risk standard under IRC § 707(a)(2)(A) and Treasury Regulation § 1.707-2, was motivated by legitimate non-tax business purposes, and is fully consistent with longstanding industry practice and applicable legal authority.
B. Factual Background
1. The Management Fee Structure
ICM's Amended and Restated Agreement of Limited Partnership, dated as of June 14, 2016, as amended through December 1, 2020 (the "LPA"), governs the economic arrangements among the partners. Section 4.1 of the LPA provides for an annual management fee equal to 2% of each limited partner's committed capital, payable quarterly in advance. This management fee structure is standard in the hedge fund industry and reflects the compensation payable to the GP and its affiliates for the ongoing investment management, administration, and operational services provided to the Fund.
For the 2021 tax year, the average committed capital of the Fund was approximately $3.58 billion. Accordingly, total management fees earned by the GP for 2021 were approximately $71.6 million ($3.58 billion × 2%).
2. The Fee Waiver Election Mechanism
Section 4.1(c) of the LPA provides the GP with an annual election to waive all or a portion of the management fees otherwise payable to it in exchange for an equivalent increase in its capital interest in the Fund. This provision was included in the original LPA at the time of the Fund's formation in 2016, at the request of several of the Fund's founding institutional investors, as a mechanism to align the GP's economic interests with those of the limited partners by increasing the GP's "skin in the game."
The fee waiver election under LPA Section 4.1(c) operates as follows:
(a) The GP may elect, on or before January 31 of each calendar year, to waive all or a specified portion of the management fees that would otherwise be payable to the GP for that calendar year.
(b) Any such election must be in writing, adopted by resolution of the managing members of the GP, and delivered to the Fund's administrator (Greystone Fund Administration LLC) prior to the commencement of the fee period to which the waiver relates.
(c) The waiver, once made, is irrevocable for the calendar year to which it relates. The GP may not subsequently reverse the waiver election and receive cash management fees for the waived portion.
(d) In consideration of the waiver, the GP receives an increase in its limited partner capital interest in the Fund equal to the dollar amount of the waived fees, as of the date the waived fees would otherwise have been payable. The increased capital interest is subject to the same terms, conditions, investment risk, lockup provisions, and withdrawal restrictions applicable to all other limited partner interests in the Fund.
(e) The GP's increased capital interest participates in all gains and losses of the Fund on the same basis and in the same proportion as all other limited partner capital interests, without any preferential allocation, priority of distribution, or downside protection.
3. The 2021 Fee Waiver Election
For the 2021 tax year, the GP elected to waive $23.8 million of its total $71.6 million management fee entitlement, representing approximately 33.2% of total management fees earned. The waiver election was adopted by written resolution of the managing members of Ironside Capital GP LLC on January 15, 2021 — sixteen days before the January 31 deadline and before the commencement of any significant investment activity for the year. A copy of the January 15, 2021 resolution was provided to the examination team as part of ICM's IDR #2 response dated June 23, 2023 (IDR #2, Bates Nos. ICM-002341 through ICM-002344).
The waiver was irrevocable once made. After January 15, 2021, the GP could not reverse the election and receive cash management fees for the $23.8 million waived amount, regardless of the Fund's subsequent investment performance.
The remaining $47.8 million of management fees ($71.6 million less $23.8 million) was paid to the GP in cash on a quarterly basis during 2021, and was reported as ordinary income on the GP's and its members' respective tax returns for 2021. There is no dispute regarding the tax treatment of the $47.8 million in cash management fees received by the GP.
4. Investment Risk on the Waived Amount
The $23.8 million of waived management fees was converted into a capital interest in the Fund that bore full investment risk — both upside and downside — identical to the investment risk borne by all other limited partners. The GP's increased capital interest was invested in the Fund's portfolio alongside all other partner capital, without any segregation, preferential allocation, priority of distribution, or downside protection. Had the Fund experienced negative investment performance in 2021, the value of the GP's increased capital interest would have declined proportionally, and the GP would have permanently forfeited the $23.8 million in cash management fees it otherwise would have received.
The Fund's multi-strategy investment approach — encompassing global macro, event-driven equity, and credit strategies — involves inherent and significant market risk, including the risk of loss of invested capital. The GP's capital interest was exposed to the full range of investment risks across all of the Fund's strategies and positions, including but not limited to market risk, credit risk, liquidity risk, counterparty risk, and geopolitical risk.
For the 2021 tax year, the Fund's gross investment return was approximately 18.7%. However, this result was unknown and unknowable at the time of the January 15, 2021 waiver election. At the time the GP made its irrevocable election, global financial markets were characterized by significant uncertainty, including ongoing concerns regarding the COVID-19 pandemic, inflation expectations, monetary policy normalization, and geopolitical tensions. The GP's decision to waive $23.8 million in cash fees and accept investment risk was a genuine entrepreneurial bet on the Fund's future performance.
5. The GP's Capital Accounts
As of December 31, 2021, the capital accounts of the GP's managing members reflected their substantial capital commitment to the Fund. Desmond R. Calloway's capital account balance was $187.4 million, and Priya Venkatesh's capital account balance was $48.6 million. These capital account balances include amounts attributable to prior-year fee waivers, performance allocations, and direct capital contributions, all of which bear the same investment risk as all other limited partner capital.
6. Third-Party Limited Partner Capital at Risk
The institutional limited partners of the Fund are sophisticated investors whose capital commitments are subject to the same investment risks as the GP's increased capital interest resulting from the fee waiver. Key limited partners include the Northgate Public Employees' Retirement System ($412 million commitment), the Marlowe Asset Management Horizon Endowment Fund ($175 million commitment), and Bramblewood Family Office LLC ($95 million commitment). All limited partner capital is subject to identical investment risk, lockup provisions, and withdrawal restrictions, without any preferential treatment or downside protection.
C. Applicable Legal Authority
1. IRC § 707(a)(2)(A) — Disguised Payments for Services
Section 707(a)(2)(A) of the Internal Revenue Code provides:
"If — (i) a partner performs services for a partnership or transfers property to a partnership, (ii) there is a related direct or indirect allocation and distribution to such partner, and (iii) the performance of such services (or such transfer) and the allocation and distribution, when viewed together, are properly characterized as a transaction occurring between the partnership and a partner acting other than in his capacity as a member of the partnership, such allocation and distribution shall be treated as a transaction described in paragraph (1) [i.e., as a transaction between the partnership and one who is not a partner]."
The purpose of § 707(a)(2)(A), as reflected in the legislative history, is to prevent partners from disguising what are in substance payments for services as partnership allocations in order to obtain preferential tax treatment. The statute operates by recharacterizing certain allocations and distributions as ordinary payments for services when the arrangement, viewed in its entirety, is more properly characterized as a fee-for-service transaction rather than a risk-sharing partnership arrangement.
However, the statute and the accompanying regulations recognize that not every arrangement in which a partner performs services and receives partnership allocations constitutes a disguised payment. The critical inquiry is whether the allocation and distribution are subject to significant entrepreneurial risk — that is, whether the partner is bearing genuine economic risk with respect to the amounts allocated, or whether the arrangement is structured to guarantee or substantially protect the partner against loss.
2. Treasury Regulation § 1.707-2 — Disguised Payments for Services
Treasury Regulation § 1.707-2(c) sets forth a six-factor test for determining whether an arrangement constitutes a disguised payment for services under § 707(a)(2)(A). The factors are:
(1) Whether the arrangement lacks significant entrepreneurial risk — that is, whether the allocation and distribution are subject to significant risk related to the overall success or failure of the partnership's business activities;
(2) Whether the partner's status as a partner is transient — for example, where the partner's interest is liquidated or substantially reduced after a short period;
(3) Whether the allocation and distribution relate to the partner's overall distributive share of partnership income — that is, whether the arrangement provides the partner with an allocation that is disproportionate to and independent of the partner's general interest in partnership profits;
(4) Whether the partner became a partner primarily to obtain tax benefits that would not have been available if the services had been rendered as a third party;
(5) Whether the value of the partner's interest in general and continuing partnership profits is small in relation to the allocation in question; and
(6) Whether the arrangement provides for distributions in a time frame comparable to the time frame that a non-partner service provider would be compensated — that is, whether the distribution is designed to occur shortly after the services are performed.
The regulations further provide that the most important factor in the analysis is whether the arrangement is subject to significant entrepreneurial risk. Treas. Reg. § 1.707-2(c)(1). Where the allocation and distribution are genuinely contingent on the overall success of the partnership's business and subject to a meaningful risk of loss, the arrangement is properly characterized as a partnership allocation rather than a disguised payment for services, even if the partner also performs services for the partnership.
3. Revenue Procedure 93-27
Revenue Procedure 93-27, 1993-2 C.B. 343, provides guidance on the tax consequences of a service provider's receipt of a partnership profits interest for services. The revenue procedure provides generally that the IRS will not treat the receipt of a profits interest for the provision of services to or for the benefit of a partnership as a taxable event for the partner or the partnership, provided certain conditions are met.
The fee waiver arrangement at issue in this examination is distinguishable from the situation addressed in Revenue Procedure 93-27. The GP is not receiving a new or additional profits interest for services; rather, the GP is voluntarily converting a portion of its contractual management fee entitlement into an at-risk capital interest in the Fund. The distinction is significant: in Revenue Procedure 93-27, the service provider receives an interest in future partnership profits that did not previously exist; in the present case, the GP is forgoing a cash fee to which it is contractually entitled and accepting instead a capital interest that bears genuine downside investment risk.
4. Relevant Case Law
Several judicial decisions inform the analysis of whether the management fee waiver at issue constitutes a disguised payment for services under § 707(a)(2)(A).
In Enterprise Mining Partners v. Commissioner, T.C. Memo. 2014-229, the Tax Court examined whether allocations to a partner performing services constituted disguised payments. The court applied the six-factor analysis of Treasury Regulation § 1.707-2 and emphasized that the determinative factor was whether the allocations were subject to significant entrepreneurial risk. The court held that allocations subject to genuine risk contingent upon the success of partnership operations were properly treated as partnership allocations rather than disguised payments.
In Canal Corp. v. Commissioner, 135 T.C. 199 (2010), the Tax Court addressed the distinction between partnership allocations and disguised payments in the context of complex partnership arrangements. The court reiterated that the fundamental inquiry is whether the economic substance of the arrangement reflects a genuine sharing of partnership risk or, instead, a transaction between the partnership and a person acting in a non-partner capacity.
In Pratt v. Commissioner, T.C. Memo. 2017-92, the Tax Court examined a profits interest arrangement and emphasized that genuine entrepreneurial risk — including the risk that the partner's interest could decline in value or become worthless — is the hallmark of a legitimate partnership allocation as distinguished from a disguised payment for services. The court noted that arrangements in which the partner's return is effectively guaranteed, protected from loss, or determined without regard to partnership performance are more properly characterized as disguised payments.
These decisions are consistent with ICM's position. The GP's management fee waiver bears genuine entrepreneurial risk: the GP irrevocably forfeited $23.8 million in cash management fees and accepted instead a capital interest that could have declined in value or been lost entirely if the Fund's investments performed poorly. The arrangement is the antithesis of a disguised payment: it is an at-risk investment of the GP's fee entitlement, subject to the same market risks borne by all other investors in the Fund.
By contrast, courts have recharacterized arrangements as disguised payments for services where the purported partnership allocation lacked genuine economic risk — for example, where the partner's return was effectively guaranteed through contractual protections, priority allocations, or retrospective election mechanisms. See, e.g., Gross v. Commissioner, T.C. Memo. 1999-254 (recharacterizing purported profit allocation as disguised payment where the partner's return was virtually certain and bore no meaningful risk of loss). The arrangement at issue here is fundamentally different: the GP assumed full investment risk on the waived amount, with no guarantee, floor, or priority of any kind.
5. IRS Guidance and Chief Counsel Advice
The IRS has addressed management fee waiver programs in the private fund context in various forms of published and internal guidance, although no formal regulatory project has been completed on this specific topic.
The IRS and Treasury Department included questions regarding management fee waiver arrangements on their Priority Guidance Plans for several years beginning in the early 2010s, signaling an awareness of these arrangements but ultimately declining to issue formal regulatory guidance specifically addressing them. The absence of affirmative regulatory action after years of consideration supports the conclusion that the IRS does not regard well-structured fee waiver arrangements — those bearing genuine entrepreneurial risk — as abusive or as per se disguised payments for services.
Chief Counsel Advice 200043014 addressed related issues in the context of partnership allocations to service partners and emphasized the importance of economic substance and entrepreneurial risk in the analysis. While this CCA did not specifically address management fee waivers, its analytical framework is consistent with the position that arrangements bearing genuine investment risk are properly characterized as partnership allocations.
Additionally, the IRS Large Business & International Division's Industry Director Directive on Partnership Issues, issued in connection with the Campaign on Carried Interest/Applicable Partnership Interests (announced in 2018), focused primarily on holding period compliance under IRC § 1061 rather than on fee waiver recharacterization under § 707(a)(2)(A). The absence of a specific IRS enforcement campaign targeting management fee waivers — despite the IRS's awareness of these arrangements — further supports the conclusion that properly structured fee waivers are not improper.
D. Analysis — The $23.8M Fee Waiver Satisfies the Entrepreneurial Risk Standard
1. Genuine Downside Exposure
The most important factor in the § 707(a)(2)(A) analysis is whether the allocation and distribution are subject to significant entrepreneurial risk. Treas. Reg. § 1.707-2(c)(1). Here, the GP's waived management fees were converted into a capital interest in the Fund that bore the full range of investment risk — including the risk of complete loss — identical to the risk borne by every other limited partner in the Fund.
In exchange for waiving $23.8 million in cash management fees, the GP received an increased capital interest in the Fund. That capital interest was invested in the Fund's portfolio on the same terms and conditions as all other partner capital, without any segregation, preferential allocation, priority of distribution, guaranteed return, loss protection, or other mechanism that would reduce or eliminate the GP's investment risk. The GP's increased capital interest participated in all gains and losses of the Fund's investment portfolio on a pari passu basis with all other limited partner interests.
If the Fund had experienced negative investment performance in 2021, the GP's increased capital interest would have declined in value in direct proportion to the Fund's losses. In a severe drawdown scenario, the GP could have lost a substantial portion — or even all — of the $23.8 million in waived fees. The GP would have received no cash management fees for the waived amount and would have suffered an investment loss on its capital interest, resulting in a permanent economic loss.
The significance of this downside exposure cannot be overstated. The GP did not merely defer receipt of its management fees; it permanently forfeited its right to receive $23.8 million in cash and accepted in exchange an investment position subject to material and uncontrollable market risk. This is the very essence of entrepreneurial risk as contemplated by the regulations.
Moreover, the Fund's investment strategies — global macro, event-driven equity, and credit — are inherently volatile and subject to substantial risk. The Fund employs leverage and takes both long and short positions across multiple asset classes and geographies, exposing the GP's capital interest to a wide range of market risks, including equity market risk, interest rate risk, credit risk, currency risk, commodity risk, liquidity risk, and geopolitical risk. The GP's decision to accept investment risk in lieu of cash fees was a genuine entrepreneurial decision, not a risk-free conversion of ordinary income to capital gain.
2. Timing and Irrevocability of the Election
The timing and irrevocability of the fee waiver election are critical factors supporting the conclusion that the arrangement bears genuine entrepreneurial risk.
The GP's waiver election was made on January 15, 2021, before the commencement of any significant investment activity for the 2021 tax year. At the time of the election, the Fund's 2021 investment performance was entirely unknown. The GP could not have known, at the time it made its irrevocable election, whether the Fund would generate positive or negative returns during 2021. The election was a prospective bet on the Fund's future performance, made under conditions of genuine uncertainty.
The irrevocability of the election is equally significant. Under LPA Section 4.1(c), the waiver election, once made, could not be reversed for the calendar year to which it related. The GP could not observe the Fund's investment performance during 2021 and then decide, after the fact, whether to waive its management fees. This distinguishes the ICM arrangement from the type of abusive "look-back" or "hindsight" fee waiver structure that the IRS has appropriately challenged — i.e., arrangements in which the manager effectively retains the option to waive fees only after ascertaining that the Fund's investment performance has been favorable, thereby eliminating any meaningful downside risk.
The prospective and irrevocable character of the GP's election is fully documented. The January 15, 2021 resolution of the managing members of the GP was executed by Desmond R. Calloway and Priya Venkatesh, delivered to Greystone Fund Administration LLC (the Fund's administrator), and recorded in the Fund's books and records. A copy of the resolution was provided to the examination team as part of ICM's IDR #2 response (IDR #2, Bates Nos. ICM-002341 through ICM-002344).
3. Application of Treasury Regulation § 1.707-2 Six-Factor Test
A systematic application of the six factors set forth in Treasury Regulation § 1.707-2(c) demonstrates that all six factors weigh in favor of characterizing the management fee waiver as a legitimate partnership allocation rather than a disguised payment for services.
Factor 1: Significant Entrepreneurial Risk. As detailed above, the GP's waived management fees were converted into a capital interest bearing full investment risk identical to that of third-party limited partners. The GP was exposed to the full downside of the Fund's investment performance, including the risk of complete loss of the waived amount. This factor weighs strongly in favor of treatment as a legitimate partnership allocation.
Factor 2: Transient Partner Status. This factor examines whether the partner's status is transient — that is, whether the partner's interest is liquidated or substantially reduced shortly after the arrangement takes effect. Here, Ironside Capital GP LLC has been the general partner of the Fund since its formation in June 2016, a period of more than five years as of the date of the 2021 fee waiver election. The GP's partnership interest is not transient; it is permanent and ongoing. The GP's increased capital interest resulting from the fee waiver is subject to the same lockup and withdrawal restrictions applicable to all limited partner interests, and no liquidation, redemption, or distribution of the GP's increased capital interest occurred in 2021 or was planned at the time of the election. This factor weighs strongly in favor of treatment as a legitimate partnership allocation.
Factor 3: Relationship to Overall Distributive Share. This factor examines whether the arrangement provides the partner with an allocation that is disproportionate to and independent of the partner's overall interest in partnership profits. The GP's capital interest resulting from the fee waiver is not disproportionate or independent; it is a component of the GP's overall economic interest in the Fund and participates in gains and losses on the same basis as all other limited partner capital. The $23.8 million waiver amount represents approximately 33.2% of the GP's total management fee entitlement and is consistent with the GP's overall economic arrangement with the Fund. The waiver does not create a special or preferential allocation; it increases the GP's capital interest in the Fund on terms identical to those of other investors. This factor weighs in favor of treatment as a legitimate partnership allocation.
Factor 4: Tax Benefit Motive. This factor examines whether the partner became a partner primarily to obtain tax benefits that would not have been available if the services had been rendered as a third party. The GP has been the general partner of the Fund since its formation and serves as the Fund's investment manager and operator. The GP did not become a partner primarily to obtain tax benefits; it is the founder and manager of the Fund and would be a partner regardless of any fee waiver arrangement. Moreover, the fee waiver program was established for legitimate non-tax business purposes, including alignment of the GP's interests with those of the limited partners and compliance with investor demands for "co-investment" and "skin in the game" arrangements. This factor weighs in favor of treatment as a legitimate partnership allocation.
Factor 5: Relative Size of Allocation. This factor examines whether the value of the partner's interest in general and continuing partnership profits is small in relation to the allocation at issue. Here, the GP's overall economic interest in the Fund is substantial. The GP is entitled to a 20% carried interest (performance allocation) and a 2% management fee, and the GP's capital account as of December 31, 2021 reflects combined capital of $187.4 million (Mr. Calloway) and $48.6 million (Ms. Venkatesh), plus additional amounts attributable to other GP members. The $23.8 million waiver amount is modest relative to the Fund's total AUM of $3.82 billion and the GP's overall economic interest. This factor weighs in favor of treatment as a legitimate partnership allocation.
Factor 6: Short-Period Distribution. This factor examines whether the arrangement provides for distributions in a time frame comparable to that in which a non-partner service provider would be compensated — that is, whether the distribution is designed to occur shortly after the services are performed. Here, the GP's increased capital interest is not subject to any near-term distribution. The capital interest is subject to the same lockup and withdrawal restrictions applicable to all limited partner interests, which include a one-year initial lockup period and quarterly withdrawal rights thereafter with 90 days' notice, subject to restrictions during periods of market stress. No distribution of the GP's increased capital interest was made in 2021 or was planned at the time of the election. This factor weighs in favor of treatment as a legitimate partnership allocation.
In sum, all six factors of the Treasury Regulation § 1.707-2(c) test weigh in favor of treating the management fee waiver as a legitimate partnership allocation rather than a disguised payment for services. The most important factor — significant entrepreneurial risk — is satisfied emphatically, as the GP bears full investment risk on the waived amount with no guarantee, floor, or downside protection of any kind.
4. Business Purpose and Investor Relations Rationale
The management fee waiver program was established at the time of the Fund's formation in 2016 for legitimate non-tax business purposes, and the 2021 fee waiver election was made for the same reasons.
First, the fee waiver program serves to align the GP's economic interests with those of the limited partners. By converting a portion of its cash management fees into an at-risk capital interest, the GP demonstrates its confidence in the Fund's investment strategy and signals to limited partners that the GP's economic interests are aligned with theirs. This alignment of interests is a core principle of institutional fund management and is widely regarded as a best practice in the alternative investment industry.
Second, the fee waiver program was established at the specific request of several of the Fund's founding institutional investors. The Northgate Public Employees' Retirement System, which committed $412 million to the Fund, and the Marlowe Asset Management Horizon Endowment Fund, which committed $175 million, both specifically requested that the Fund's LPA include a fee waiver mechanism as a condition of their capital commitments. These investors view the GP's willingness to accept investment risk in lieu of cash fees as evidence of the GP's conviction in the Fund's strategy and as a meaningful alignment mechanism that benefits all limited partners.
Third, the fee waiver arrangement was fully disclosed to all limited partners and described in the Fund's offering documents, including the Confidential Private Placement Memorandum dated June 2016 (as supplemented) and the LPA. All limited partners were aware of and consented to the arrangement as part of their subscription to the Fund.
Fourth, the fee waiver arrangement is a well-established and widely used practice in the hedge fund and private equity industry. Management fee waiver programs are employed by many of the largest and most reputable fund managers, and are recognized by institutional investors, industry associations, and market participants as a legitimate mechanism for aligning the interests of fund managers and investors. The ICM arrangement is consistent with industry norms and standards.
E. Conclusion on Issue 1
For all of the foregoing reasons, the $23.8 million management fee waiver does not constitute a disguised payment for services under IRC § 707(a)(2)(A). The waiver bears genuine entrepreneurial risk, was elected prospectively and irrevocably before the commencement of the fee period, converts the GP's fee entitlement into an at-risk capital interest bearing full investment risk identical to that of third-party limited partners, satisfies all six factors of the disguised payment analysis under Treasury Regulation § 1.707-2(c), and was motivated by legitimate non-tax business purposes. The arrangement is fully consistent with the statutory and regulatory framework, judicial precedent, and published IRS guidance. No adjustment is warranted on Issue 1.
III. ISSUE 2 — CARRIED INTEREST HOLDING PERIOD UNDER IRC § 1061
A. Statement of the Issue
The second issue under examination is whether $38.7 million of the $94.3 million total performance allocation to the GP for the 2021 tax year qualifies for long-term capital gain treatment under IRC § 1061.
Section 1061 of the Internal Revenue Code, enacted by the Tax Cuts and Jobs Act of 2017, extends the holding period requirement for long-term capital gain treatment of income attributable to "applicable partnership interests" — commonly known as "carried interest" — from one year to three years. Under § 1061(a), net long-term capital gain with respect to an applicable partnership interest is treated as short-term capital gain (and taxed at ordinary income rates of up to 37%) to the extent the gain is attributable to partnership assets held for three years or less.
The IRS examination team has questioned whether 14 specific positions liquidated by the Fund in 2021, whose gains are included in the $38.7 million at issue, satisfied the three-year holding period requirement of § 1061(a). If the IRS were to sustain the proposed adjustment, the potential tax impact to the GP and its members would be approximately $6.579 million, representing the 17 percentage point rate differential between the 37% short-term capital gain rate and the 20% long-term capital gain rate applied to $38.7 million.
ICM submits that all 14 positions at issue were held for in excess of three years prior to their disposition in 2021, and that the $38.7 million in performance allocations is properly treated as long-term capital gain under § 1061. The holding periods are fully documented by trade-level records from the Fund's prime broker, internal portfolio management systems, fund administration records, and tax return preparation workpapers.
B. Factual Background
1. The Performance Allocation Structure
Section 5.2 of the LPA provides for a performance allocation (commonly referred to as "carried interest") equal to 20% of each limited partner's net profits for each fiscal year, above an 8% annualized preferred return hurdle with a full catch-up provision. The performance allocation is structured as a special allocation of partnership income (including capital gains) to the GP, rather than as a fee payable by the Fund.
For the 2021 tax year, total performance allocations to the GP were $94.3 million, reflecting the Fund's gross investment return of approximately 18.7% and the application of the 20% carried interest above the 8% preferred return hurdle. Of this $94.3 million, $55.6 million is attributable to gains on assets held for more than three years that are not in dispute, and $38.7 million is the amount at issue, attributable to gains on the 14 specific positions questioned by the examination team.
2. The 14 Challenged Positions
The IRS has identified 14 positions whose liquidation during 2021 generated gains included in the $38.7 million at issue. These positions span the Fund's global macro, event-driven equity, and credit strategies and include equity securities, corporate bonds, sovereign debt instruments, and structured credit positions. All 14 positions were acquired by the Fund through arm's-length market transactions executed through Ridgeline Securities LLC, the Fund's prime broker.
A detailed trade-level holding period analysis for each of the 14 positions was provided to the examination team as part of ICM's IDR #3 response dated July 28, 2023 (IDR #3, Bates Nos. ICM-003512 through ICM-003688). That analysis was prepared by Robert Jansen, an associate in the Tax Department of Calderwood & Harkness LLP, under the supervision of the undersigned, and was based on trade confirmations from Ridgeline Securities LLC, internal trade blotters maintained by ICM's portfolio management team, portfolio management system records, and Borwick Craine & Associates LLP tax return preparation workpapers.
The holding period schedule submitted with the IDR #3 response contains, for each of the 14 positions, the following information:
• Position identifier and security/instrument name
• Acquisition date(s) and method of acquisition
• Disposition date(s) and method of disposition
• Holding period in calendar days and years
• Acquisition cost (tax basis)
• Sale proceeds
• Gain or loss amount
• Long-term versus short-term capital gain classification
• Cross-reference to Ridgeline Securities LLC trade confirmation number(s)
All 14 positions reflected in the holding period schedule show a holding period exceeding 1,095 days (three years), with the shortest holding period among the 14 positions being well in excess of three years. The total gains attributable to these 14 positions aggregate to the $38.7 million at issue.
3. Corroborating Documentation
The holding periods for the 14 challenged positions are corroborated by multiple independent sources of documentation:
Ridgeline Securities LLC Trade Confirmations. For each of the 14 positions, Ridgeline Securities LLC issued trade confirmations at the time of acquisition and at the time of disposition. The trade confirmations specify the trade date, settlement date, security description, quantity, price, and counterparty for each transaction. Copies of all relevant trade confirmations were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003689 through ICM-003842).
Internal Trade Blotters and Portfolio Management System Records. ICM maintains contemporaneous internal trade blotters and portfolio management system records that document all trades executed on behalf of the Fund. These records were generated by ICM's order management system at the time each trade was executed and were maintained in the ordinary course of business. The trade blotters confirm the acquisition and disposition dates for each of the 14 positions. Relevant excerpts were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003843 through ICM-003901).
Borwick Craine & Associates LLP Workpapers. Borwick Craine & Associates LLP, the Fund's independent public accounting firm, prepared workpapers in connection with the preparation of ICM's 2021 Form 1065 that reconcile the reported gains on the 14 positions to the Fund's books and records. These workpapers were prepared under the supervision of Elliot Navarro, CPA, engagement partner for tax, and confirm the acquisition dates, disposition dates, holding periods, and gain amounts for each of the 14 positions. The workpapers were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003902 through ICM-003958).
Greystone Fund Administration LLC NAV Calculations. Greystone Fund Administration LLC, the Fund's independent third-party administrator, performs net asset value ("NAV") calculations for the Fund on a daily basis. The NAV calculations confirm the performance allocation amounts for 2021, including the amounts attributable to the 14 positions at issue. Relevant excerpts of the NAV calculations were included in the IDR #3 response (IDR #3, Bates Nos. ICM-003959 through ICM-004012).
C. Applicable Legal Authority
1. IRC § 1061 — Partnership Interests Held in Connection with Performance of Services
Section 1061 was enacted as part of the Tax Cuts and Jobs Act of 2017, P.L. 115-97, § 13309, effective for taxable years beginning after December 31, 2017. The provision was adopted in response to longstanding policy concerns regarding the taxation of carried interest income at preferential long-term capital gain rates.
Section 1061(a) provides:
"If one or more applicable partnership interests are held by a taxpayer at any time during the taxable year, the excess (if any) of — (A) the taxpayer's net long-term capital gain with respect to such interests for such taxable year, over (B) the taxpayer's net long-term capital gain with respect to such interests for such taxable year computed by applying paragraphs (3) and (4) of section 1222 by substituting '3 years' for '1 year', shall be treated as short-term capital gain, notwithstanding section 83 or any election in effect under section 83(b)."
In other words, § 1061(a) requires that gains attributable to applicable partnership interests be held for more than three years (rather than the standard one year) in order to qualify for long-term capital gain treatment. Gains attributable to assets held for three years or less are recharacterized as short-term capital gain and taxed at ordinary income rates.
Section 1061(c)(1) defines an "applicable partnership interest" as "any interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any applicable trade or business." Section 1061(c)(2) defines an "applicable trade or business" to include, among other things, any activity conducted on a regular, continuous, and substantial basis which consists, in whole or in part, of "raising or returning capital, and either — (i) investing in (or disposing of) specified assets (or identifying specified assets for such investing or disposition), or (ii) developing specified assets."
2. Treasury Regulation §§ 1.1061-1 through 1.1061-6
The Treasury Department and the IRS issued final regulations under § 1061 on January 7, 2021 (T.D. 9945, 86 Fed. Reg. 5,454), effective for tax years beginning after December 31, 2017. These regulations provide comprehensive guidance on the application of § 1061, including the determination of the three-year holding period.
Treasury Regulation § 1.1061-4 sets forth the rules for calculating the recharacterization amount under § 1061(a). Under Treas. Reg. § 1.1061-4(a)(1), the amount recharacterized as short-term capital gain is the "API One Year Distributive Share Amount" minus the "API Three Year Distributive Share Amount." The API Three Year Distributive Share Amount includes only items of long-term capital gain and loss that would be treated as long-term capital gain or loss if a three-year holding period were substituted for the standard one-year holding period.
Critically, the holding period is measured at the asset level — that is, the holding period of the underlying partnership assets, not the holding period of the partner's interest in the partnership. Treas. Reg. § 1.1061-4(b)(7). This asset-level measurement ensures that the three-year holding period requirement is applied based on the actual holding period of the investments generating the gains, regardless of when the partner acquired or transferred its partnership interest.
The regulations also permit aggregation and netting within the holding period determination, as provided in Treas. Reg. § 1.1061-4(a)(3), and provide specific rules for tiered partnership structures, lookthrough computations, and transfers of applicable partnership interests.
3. Legislative History
The Conference Report to the Tax Cuts and Jobs Act, H.R. Rep. No. 115-466, at 433-34 (2017), confirms that the purpose of § 1061 is to require fund managers receiving carried interest allocations to hold the underlying investments for more than three years in order to obtain long-term capital gain treatment. The Conference Report states:
"Under the provision, if one or more applicable partnership interests are held by a taxpayer at any time during the taxable year, the excess (if any) of the taxpayer's net long-term capital gain with respect to such interests for such taxable year, over the taxpayer's net long-term capital gain with respect to such interests for such taxable year computed by applying a three-year (rather than a one-year) holding period, is treated as short-term capital gain."
The legislative history further confirms that § 1061 is intended to apply to carried interest allocations in the context of asset management, including hedge funds, private equity funds, and real estate funds, and is not intended to alter the fundamental partnership taxation framework or to apply to capital interests acquired by partners through capital contributions.
D. Analysis — All 14 Positions Satisfy the Three-Year Holding Period
1. Trade-Level Evidence
The holding period analysis submitted with ICM's IDR #3 response on July 28, 2023 provides trade-level evidence establishing that all 14 positions at issue were held by the Fund for in excess of three years (1,095 days) prior to their disposition in 2021. The analysis was prepared by Robert Jansen of Calderwood & Harkness LLP based on Ridgeline Securities LLC trade confirmations, internal trade blotters, portfolio management system records, and Borwick Craine & Associates LLP tax return preparation workpapers.
The holding period schedule (an Excel workbook containing detailed position-by-position data) demonstrates that the acquisition dates for all 14 positions fall on or before the relevant dates in 2018 that would be necessary to satisfy a three-year holding period for dispositions occurring in 2021. The specific acquisition dates, disposition dates, and holding periods for each position are set forth in the schedule, with each position showing a holding period that exceeds 1,095 days by a substantial margin.
The total gains attributable to the 14 positions aggregate to $38.7 million, all of which qualifies for long-term capital gain treatment under the three-year holding period rule of § 1061(a).
2. Corroborating Documentation
As described in Section III.B.3 above, the holding periods for the 14 positions are corroborated by four independent sources of documentation: (i) Ridgeline Securities LLC trade confirmations, which provide contemporaneous, third-party evidence of the trade dates for each acquisition and disposition; (ii) ICM's internal trade blotters and portfolio management system records, which were generated in the ordinary course of business at the time each trade was executed; (iii) Borwick Craine & Associates LLP workpapers, which reconcile the reported gains to the Fund's books and records; and (iv) Greystone Fund Administration LLC NAV calculations, which confirm the performance allocation amounts.
The consistency of the holding period data across these four independent sources provides strong corroborative evidence that the acquisition dates and holding periods reported on ICM's 2021 Form 1065 are accurate. There are no discrepancies between the trade confirmations, internal records, accounting workpapers, and fund administration records with respect to the acquisition or disposition dates for any of the 14 positions.
3. Application of Treasury Regulation § 1.1061-4
ICM's GP holds an "applicable partnership interest" within the meaning of IRC § 1061(c)(1), as the GP's interest in the Fund is held in connection with the performance of substantial services by the GP and its members in an applicable trade or business (investment management). Accordingly, the three-year holding period requirement of § 1061(a) applies to gains allocable to the GP's carried interest.
However, because all of the gains at issue — the $38.7 million attributable to the 14 challenged positions — are attributable to assets held by the Fund for more than three years, no recharacterization under § 1061(a) is required. Applying the framework of Treasury Regulation § 1.1061-4(a):
(a) The "API One Year Distributive Share Amount" includes the $38.7 million in gains, as all 14 positions were held for more than one year.
(b) The "API Three Year Distributive Share Amount" also includes the $38.7 million in gains, as all 14 positions were held for more than three years.
(c) The "One API Recharacterization Amount" — calculated as the API One Year Distributive Share Amount minus the API Three Year Distributive Share Amount — is therefore zero with respect to these 14 positions.
Because the One API Recharacterization Amount is zero, no portion of the $38.7 million in gains is recharacterized as short-term capital gain under § 1061(a), and the full amount is properly treated as long-term capital gain taxable at the 20% rate.
4. Responses to Specific IRS Questions from July 14, 2023 Meeting
At the in-person meeting held on July 14, 2023 at the IRS Manhattan Campus (290 Broadway, New York, NY 10007), IRS Counsel Eric S. Lundgren raised several specific questions regarding the documentation of acquisition dates for certain of the 14 positions. ICM addresses each of those questions below.
Question regarding complex or structured positions. Mr. Lundgren asked whether an

LEGAL MEMORANDUM OF IRONSIDE CAPITAL MANAGEMENT LP IN SUPPORT OF POSITIONS TAKEN ON 2021 PARTNERSHIP RETURN (FORM 1065)

I. INTRODUCTION AND EXECUTIVE SUMMARY

Record

Parties

Dates

Amounts