PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT ATTORNEY-CLIENT PRIVILEGE
CALDERWOOD & HARKNESS LLP
Internal File Memorandum
Date: October 18, 2023
From: Leila Nazari, Associate, Tax Department
To: Sylvia Hartwell, Partner, Tax Department Leonard Cross, Partner, Tax Department
Re: Matter Closing Summary — IRS Partnership Examination of Ironside Capital Management LP (EIN 83-2741956), Tax Year 2021
Matter Number: 1023-00003
Matter Status: CLOSED / TERMINATED
This memorandum constitutes attorney work product prepared in anticipation of litigation and is protected by the attorney-client privilege. It is intended solely for the use of the addressees identified above and should not be disclosed to any person outside the firm without the prior written consent of the responsible partner. Distribution is limited to the individuals identified on the distribution list set forth at the conclusion of this memorandum.
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I. Executive Summary
Calderwood & Harkness LLP ("C&H" or the "Firm") represented Ironside Capital Management LP ("ICM"), a Delaware limited partnership operating as a multi-strategy hedge fund (EIN 83-2741956), in connection with an examination conducted by the Internal Revenue Service, Large Business & International Division ("LB&I"), of ICM's federal partnership income tax return (Form 1065) for the tax year ended December 31, 2021. The 2021 Form 1065 was timely filed on extension on September 15, 2022, and was prepared by ICM's outside accounting firm, Borwick Craine & Associates LLP.
The examination was initiated by IRS Letter 2205-D dated March 22, 2023, which was received by ICM at its principal office on March 29, 2023. Marcus Trent, ICM's General Counsel, contacted Calderwood & Harkness on April 5, 2023, and the Firm's engagement was formalized through execution of the engagement letter on April 10, 2023.
During the course of the examination, the IRS examined three discrete issues:
1. Management Fee Waiver Recharacterization (IRC § 707(a)(2)(A)): The IRS questioned whether $23.8 million in management fees waived by the general partner, Ironside Capital GP LLC, in exchange for an increased capital interest constituted a disguised payment for services that should be recharacterized as ordinary income rather than treated as a capital interest giving rise to long-term capital gain upon subsequent fund appreciation.
2. Carried Interest Holding Period Challenge (IRC § 1061): The IRS challenged $38.7 million of the $94.3 million in total performance allocations to the general partner, questioning whether fourteen specific liquidated positions satisfied the three-year holding period required by Section 1061 of the Internal Revenue Code for long-term capital gain treatment.
3. Organizational/Syndication Cost Reclassification (IRC §§ 709 and 195): The IRS questioned whether $680,000 of the $1.42 million in total costs deducted under IRC § 709(b) as organizational expenses was properly classified, or whether such amounts should have been classified as non-deductible syndication costs under IRC § 709(a).
The total potential partnership-level adjustment across all three issues was $63.18 million. Had the IRS prevailed on all issues, the estimated aggregate tax impact across all partners would have been approximately $11.78 million.
On October 14, 2023, the IRS issued a no-change letter (Letter 4396-A) under the authority of Territory Manager Karen P. Driscoll, formally closing the examination without any adjustments. All positions reported on ICM's 2021 Form 1065 were upheld. No Form 8986 (Partner's Share of Adjustment) was issued, and no computational adjustments were proposed at any point during the examination.
The total engagement cost for this matter was $501,630.00, consisting of $487,350.00 in professional fees and $14,280.00 in reimbursable expenses. All invoices have been paid in full by the client.
This memorandum summarizes the background of the engagement, the chronology of key events, the issues examined and their resolution, key documents and work product, financial details of the engagement, and recommendations for future audit preparedness.
II. Client and Matter Background
A. Client Information
Client: Ironside Capital Management LP, a Delaware limited partnership formed on June 14, 2016, pursuant to a Certificate of Limited Partnership filed with the Delaware Secretary of State and governed by the Amended and Restated Limited Partnership Agreement dated June 14, 2016, as amended from time to time (the "LPA").
Headquarters: 590 Madison Avenue, 28th Floor, New York, New York 10022.
Registered Agent: Capitol Statutory Services LLC, 1209 Orange Street, Wilmington, Delaware 19801.
Employer Identification Number (EIN): 83-2741956.
Business Description: ICM operates as a multi-strategy hedge fund employing a diversified investment approach across global macro, event-driven equity, and credit strategies. The fund invests in both domestic and international markets and utilizes a combination of long and short positions across equity, fixed income, and derivative instruments. As of December 31, 2021, ICM reported assets under management ("AUM") of approximately $3.82 billion, as reflected on the 2021 Form 1065, Schedule L (Balance Sheets per Books).
Partners: As of December 31, 2021, ICM had forty-seven (47) limited partners and one general partner. The limited partners consist of a mix of institutional investors (including public pension funds, endowments, and foundations), family offices, and high-net-worth individuals.
General Partner: Ironside Capital GP LLC, a Delaware limited liability company (EIN 83-2741890), serves as the sole general partner of ICM. Ironside Capital GP LLC was formed on June 10, 2016, and is governed by an Amended and Restated Limited Liability Company Agreement of the same date.
Managing Members of the General Partner:
• Desmond R. Calloway — Founder and Chief Investment Officer. Mr. Calloway holds a 62% membership interest in Ironside Capital GP LLC and maintained a capital account balance in ICM of approximately $187.4 million as of December 31, 2021. Mr. Calloway is responsible for all investment decision-making and portfolio management functions.
• Priya Venkatesh — Chief Operating Officer and Chief Financial Officer. Ms. Venkatesh holds a 28% membership interest in Ironside Capital GP LLC and maintained a capital account balance in ICM of approximately $48.6 million as of December 31, 2021. Ms. Venkatesh is responsible for fund operations, risk management, investor relations, and financial reporting.
• Remaining GP Interest: The remaining 10% membership interest in Ironside Capital GP LLC is held by other members of the GP, including senior portfolio managers and the fund's head of compliance.
General Counsel (Primary Client Contact): Marcus Trent, Esq., serves as General Counsel of Ironside Capital GP LLC and was the primary day-to-day client contact throughout the course of the engagement. Mr. Trent coordinated document production, facilitated communications with Borwick Craine & Associates LLP and other third-party service providers, and liaised with Desmond R. Calloway and Priya Venkatesh as necessary on substantive and strategic matters.
B. Fund Economics — Tax Year 2021
An understanding of ICM's fee structure and economic terms for the 2021 tax year is essential to the issues examined. The following summary is derived from the LPA and the 2021 Form 1065, Schedules K and K-1:
Management Fees. Pursuant to Section 4.1 of the LPA, ICM pays an annual management fee equal to 2% of committed capital to Ironside Capital GP LLC for investment management and advisory services. For the tax year ended December 31, 2021, average committed capital across all limited partners was approximately $3.58 billion, resulting in total management fees of $71.6 million. Management fees are payable quarterly in advance and are computed based on each limited partner's committed capital (rather than net asset value), consistent with industry practice for institutional-quality hedge funds.
Carried Interest / Performance Allocations. Pursuant to Section 5.2 of the LPA, Ironside Capital GP LLC is entitled to a performance allocation (commonly referred to as "carried interest") equal to 20% of net profits above a preferred return of 8% per annum, with a full catch-up provision. For the 2021 tax year, the gross fund return was approximately 18.7%, and total performance allocations to the general partner were $94.3 million. The performance allocation is computed on a partner-by-partner basis (i.e., at the individual limited partner level), with a high-water mark and loss carryforward provisions, as specified in Sections 5.3 and 5.4 of the LPA.
Management Fee Waiver. Of particular significance to this examination, Ironside Capital GP LLC elected to waive $23.8 million of the $71.6 million in management fees to which it was entitled for the 2021 tax year. In exchange for the waived fees, the GP received an increased interest in ICM's investment portfolio (i.e., an additional capital interest in the fund). This management fee waiver election was made pursuant to a side letter agreement dated January 15, 2021, between Ironside Capital GP LLC and ICM, and was documented through a GP Resolution dated January 18, 2021, and a contemporaneous memorandum prepared by Priya Venkatesh dated January 20, 2021, analyzing the economic risks and business rationale for the election. The waiver was structured to expose the GP to genuine entrepreneurial risk—that is, the GP bore the downside risk that the value of the additional capital interest could decline below the amount of the waived management fees.
C. Key Third Parties
The following third parties played significant roles in the examination, either as document custodians, sources of information, or otherwise:
Auditor and Tax Return Preparer: Borwick Craine & Associates LLP. Borwick Craine & Associates LLP ("Fenwick Craine") serves as ICM's independent auditor and tax return preparer. Fenwick Craine maintains its principal office at 3 World Financial Center, Suite 2400, New York, New York 10281. The key engagement personnel at Fenwick Craine for the ICM relationship are:
• Sandra Whitmore — Engagement Partner, Audit. Ms. Whitmore is responsible for the annual financial statement audit of ICM and provided audited financial statements referenced during the examination.
• Elliot Navarro — Engagement Partner, Tax. Mr. Navarro is responsible for the preparation of ICM's annual federal and state partnership income tax returns (Form 1065 and associated state filings) and related Schedules K-1. Mr. Navarro's team prepared the 2021 Form 1065 that was the subject of the examination and provided tax workpapers responsive to IDR requests during the course of the engagement.
Fund Administrator: Greystone Fund Administration LLC. Greystone Fund Administration LLC ("Greystone") serves as ICM's independent fund administrator and is responsible for NAV calculations, investor allocations, capital account maintenance, and investor reporting. Greystone provided partnership allocation schedules and capital account reconciliations in response to certain IDR items.
Prime Broker: Ridgeline Securities LLC. Ridgeline Securities LLC ("Ridgeline") serves as ICM's primary prime broker and custodian. Ridgeline provided trade confirmations, holding period data, and transaction-level records that were instrumental in the defense of the IRC § 1061 holding period issue.
Key Limited Partners Referenced in Examination. The IRS examination team referenced certain limited partners and their capital commitments during the course of the examination, including:
• Northgate Public Employees' Retirement System — $412 million capital commitment. As a tax-exempt pension fund, Northgate's participation was relevant to certain UBTI and allocation questions raised incidentally during the examination, though no formal issue was raised.
• Bramblewood Family Office LLC — $95 million capital commitment. Bramblewood was referenced in connection with the management fee waiver analysis, as the fee waiver arrangement had implications for the allocation of income and expenses among all partners.
• Marlowe Asset Management Horizon Endowment Fund — $175 million capital commitment. Marlowe Asset Management Horizon was referenced in the context of the organizational/syndication cost issue.
D. Engagement Team
The following Calderwood & Harkness LLP professionals staffed this engagement:
Responsible Partner: Sylvia Hartwell. Ms. Hartwell is a partner in the Firm's Tax Department with nineteen (19) years of experience in partnership tax controversy matters, including extensive experience defending hedge fund and private equity fund clients in IRS examinations. Ms. Hartwell served as the lead attorney and primary contact with the IRS examination team throughout the engagement. She led the in-person meeting at the IRS Manhattan Campus on July 14, 2023, and was the principal author of the comprehensive legal memorandum submitted on September 6, 2023.
Billing Partner: Leonard Cross. Mr. Cross is a partner in the Firm's Tax Department and serves as the relationship partner for the Ironside Capital Management engagement. Mr. Cross's involvement in this matter was limited to initial strategy discussions, periodic status updates, and review of the final engagement correspondence. Mr. Cross maintained the client relationship and communicated with senior ICM management as appropriate.
Lead Associate: Leila Nazari. Ms. Nazari is a sixth-year associate in the Firm's Tax Department and served as the lead associate on this engagement. Ms. Nazari was responsible for day-to-day case management, coordination of document production with Marcus Trent and Fenwick Craine, drafting of IDR response cover letters and factual narratives, preparation of the comprehensive legal memorandum (in collaboration with Ms. Hartwell), and all formal and informal communications with the IRS examination team. Ms. Nazari also served as an authorized representative under the Form 2848 filed with the IRS.
Working Associate: Robert Jansen. Mr. Jansen is a third-year associate in the Firm's Tax Department and provided substantial analytical support throughout the engagement. Mr. Jansen was principally responsible for the trade-level holding period analysis underlying the IRC § 1061 issue, including the preparation of detailed schedules identifying acquisition and disposition dates, gain/loss calculations, and cross-references to Ridgeline Securities LLC trade confirmations for all fourteen challenged positions.
E. IRS Examination Team
The IRS examination team for this matter consisted of the following personnel, all assigned to the LB&I Pass-Through Entities Practice Area at the IRS Manhattan Campus:
Territory Manager: Karen P. Driscoll. Ms. Driscoll served as the Territory Manager within the Pass-Through Entities Practice Area responsible for overseeing the examination of ICM. The no-change letter (Letter 4396-A) was issued under her authority. Ms. Driscoll did not participate directly in any meetings or communications with Calderwood & Harkness but was identified as the approving official on the closing letter.
Lead Examiner: Timothy J. Albrecht. Revenue Agent Albrecht, GS-13, Badge No. 74-28193, served as the lead examiner throughout the examination. RA Albrecht was responsible for issuing all four Information Document Requests, conducting the substantive review of documents produced, and communicating preliminary findings. RA Albrecht was present at the in-person meeting on July 14, 2023, and participated in all telephonic conferences.
Supporting Agent: Dawn M. Petrovic. Revenue Agent Petrovic, GS-12, served as the supporting agent on the examination. RA Petrovic assisted RA Albrecht in reviewing the voluminous documents produced in response to IDR #1 and participated in the telephone conference on June 9, 2023, and the in-person meeting on July 14, 2023.
IRS Counsel: Eric S. Lundgren. Mr. Lundgren is an attorney in the Office of Chief Counsel, Large Business & International, Branch 5. Mr. Lundgren provided legal support to the examination team and was principally focused on the management fee waiver issue under IRC § 707(a)(2)(A) and the holding period issue under IRC § 1061. Mr. Lundgren participated in the in-person meeting on July 14, 2023, where he posed specific questions regarding the holding period documentation for the fourteen challenged positions, and participated in the follow-up teleconference on September 22, 2023.
III. Engagement History and Chronology
This section sets forth a detailed chronology of the engagement from the initiation of the IRS examination through the issuance of the no-change letter and closing of the matter.
A. Engagement Opening
March 22, 2023: The IRS issued Letter 2205-D to Ironside Capital Management LP at its principal office at 590 Madison Avenue, 28th Floor, New York, New York 10022, formally initiating an examination of ICM's 2021 Form 1065 (U.S. Return of Partnership Income). The letter identified the tax year under examination as the year ended December 31, 2021, and was signed by Revenue Agent Timothy J. Albrecht.
March 29, 2023: Letter 2205-D was received by ICM's administrative staff and routed to Marcus Trent, General Counsel, on the same business day.
April 5, 2023: Marcus Trent contacted Calderwood & Harkness LLP by telephone and email to discuss the examination. Mr. Trent spoke with Sylvia Hartwell and provided an initial overview of the examination notice, the relevant tax return positions, and ICM's internal documentation. Ms. Hartwell conducted a preliminary conflict check and confirmed that the Firm was available to accept the engagement.
April 10, 2023: The engagement letter between ICM and Calderwood & Harkness LLP was executed by Marcus Trent on behalf of ICM and by Sylvia Hartwell on behalf of the Firm. The engagement letter established an hourly fee arrangement with the following billing rates:
• Sylvia Hartwell, Partner: $1,350 per hour
• Leonard Cross, Partner: $1,275 per hour
• Leila Nazari, Associate: $895 per hour
• Robert Jansen, Associate: $725 per hour
The engagement letter also provided for reimbursement of reasonable out-of-pocket expenses, including travel, copying, courier, and electronic research charges.
April 14, 2023: Calderwood & Harkness filed Form 2848 (Power of Attorney and Declaration of Representative) with the IRS, designating Sylvia Hartwell and Leila Nazari as authorized representatives of Ironside Capital Management LP for purposes of the examination. The Form 2848 covered the 2021 tax year and all federal tax matters related thereto. A copy of the executed Form 2848 was transmitted to RA Albrecht at the IRS LB&I Manhattan Campus, 290 Broadway, New York, New York 10007, together with a cover letter introducing the Firm as ICM's representatives and requesting that all further communications be directed to Ms. Hartwell and Ms. Nazari.
B. Information Document Requests and Responses
The IRS issued a total of four Information Document Requests ("IDRs") during the course of the examination, encompassing eighty (80) individual items. Each IDR was responded to within the timeframe established by the IRS examination team, and in several instances responses were submitted ahead of the agreed-upon deadline. The following subsections describe each IDR and the corresponding response in detail.
IDR #1 — General Books and Records
April 28, 2023: IDR #1 was received from Revenue Agent Albrecht. IDR #1 contained forty-two (42) items requesting a comprehensive set of general books and records related to ICM's 2021 tax year. The request encompassed, among other categories, the following:
• Complete copy of the 2021 Form 1065 as filed, including all schedules and attachments;
• Audited financial statements for the year ended December 31, 2021;
• The Amended and Restated Limited Partnership Agreement, as amended;
• Schedule of partners, including name, EIN/SSN, capital account balances, and profit/loss sharing percentages;
• General ledger and trial balance for the 2021 fiscal year;
• Bank and brokerage account statements;
• Documentation of all material transactions and positions;
• Tax depreciation schedules;
• Reconciliation of book income to taxable income (Schedule M-1 and M-3 support);
• Management fee calculation workpapers;
• Performance allocation (carried interest) calculation workpapers;
• Documentation of organizational and startup costs, including deductions claimed under IRC § 709(b);
• Partnership agreement amendments, side letters, and supplemental agreements.
May 19, 2023: Calderwood & Harkness submitted the response to IDR #1, consisting of a cover letter addressed to RA Albrecht at the IRS LB&I Manhattan Campus, 290 Broadway, New York, New York 10007, accompanied by 2,847 pages of documents and workpapers. The documents were organized by IDR item number and transmitted in both hard copy (via courier) and electronic format (via encrypted file transfer). The production included, among other things, the complete filed return, audited financial statements, the LPA, all current amendments and side letters, partner schedules prepared by Greystone Fund Administration LLC, the general ledger and trial balance prepared by Fenwick Craine, management fee and carried interest calculation workpapers, and organizational cost documentation. Marcus Trent and Elliot Navarro of Fenwick Craine reviewed the production prior to submission to ensure completeness and accuracy.
IDR #2 — Management Fee Waiver Mechanics
June 2, 2023: IDR #2 was received from RA Albrecht. IDR #2 contained eighteen (18) items specifically focused on the mechanics of the management fee waiver arrangement. The items requested, among other things:
• The side letter agreement between Ironside Capital GP LLC and ICM governing the fee waiver;
• GP resolutions authorizing the waiver election;
• Contemporaneous memoranda or analyses prepared by fund management in connection with the waiver;
• Calculation of the amount of fees waived and the corresponding increase in capital interest;
• Documentation of the economic terms of the increased capital interest, including downside risk exposure;
• Correspondence with limited partners regarding the fee waiver;
• Historical fee waiver elections for prior tax years (2018–2020);
• Tax treatment of the waiver on the 2021 Form 1065 and individual K-1s.
June 9, 2023: A telephone conference was held between Sylvia Hartwell and Leila Nazari (Calderwood & Harkness) and Timothy J. Albrecht and Dawn M. Petrovic (IRS) to discuss the scope of the examination. During this call, RA Albrecht confirmed that the examination was focused on the three issues identified above—the management fee waiver, carried interest holding periods, and organizational/syndication cost classification. Ms. Hartwell inquired as to whether additional issues were anticipated, and RA Albrecht indicated that no additional issues were contemplated at that time. The parties also discussed the timeline for document production, and RA Albrecht agreed to a response deadline of June 23, 2023, for IDR #2.
June 23, 2023: Calderwood & Harkness submitted the response to IDR #2, consisting of a cover letter and a detailed factual narrative explaining the $23.8 million management fee waiver. The submission included the following key documents and analyses:
• The side letter agreement dated January 15, 2021, between Ironside Capital GP LLC and ICM, executed by Desmond R. Calloway and countersigned by Marcus Trent;
• The GP Resolution dated January 18, 2021, unanimously authorizing the fee waiver election for the 2021 tax year;
• The contemporaneous memorandum prepared by Priya Venkatesh dated January 20, 2021, setting forth the economic analysis underlying the waiver election, including a detailed discussion of the downside risk borne by the GP;
• Workpapers showing the calculation of the $23.8 million waiver amount, the corresponding increase in capital interest, and the allocation of such interest across the GP's capital account;
• Documentation of the economic substance of the arrangement, including evidence that the GP bore genuine downside risk (i.e., the risk that fund performance could result in the additional capital interest being worth less than the management fees foregone);
• Historical fee waiver documentation for tax years 2018 through 2020, demonstrating a consistent pattern of fee waiver elections;
• Relevant LPA provisions (Sections 4.1 and 5.2) governing management fees and performance allocations.
The factual narrative submitted with the IDR #2 response emphasized the entrepreneurial risk character of the arrangement, the genuine economic substance of the GP's exposure to downside risk, and the distinction between the ICM fee waiver structure and the types of abusive fee conversion arrangements that have been the subject of IRS enforcement activity and adverse judicial decisions.
IDR #3 — Carried Interest Holding Period
July 11, 2023: IDR #3 was received from RA Albrecht. IDR #3 contained twelve (12) items focused on carried interest holding period documentation under IRC § 1061, which was enacted as part of the Tax Cuts and Jobs Act of 2017. The items requested, among other things:
• Identification of all positions contributing to the $94.3 million in total performance allocations for 2021;
• Specific identification of positions with a holding period of less than three years;
• Trade-level acquisition and disposition dates for all positions liquidated during 2021 that generated gain;
• Gain/loss calculations for each such position;
• Supporting documentation from the prime broker (Ridgeline Securities LLC), including trade confirmations and statements;
• Documentation of the fund's methodology for tracking holding periods under IRC § 1061;
• Workpapers reflecting the partnership's computation of the "applicable partnership interest" adjustment under IRC § 1061(a) and (d).
July 28, 2023: Calderwood & Harkness submitted the response to IDR #3, consisting of a cover letter accompanied by a comprehensive trade-level holding period analysis. This analysis was prepared by Robert Jansen and reviewed by Leila Nazari and Sylvia Hartwell. The analysis addressed each of the fourteen (14) positions specifically identified by the IRS as potentially failing to satisfy the three-year holding period required by IRC § 1061. For each of the fourteen positions, the response provided:
• The security name, CUSIP/ISIN, and description;
• The acquisition date (or dates, in the case of positions built over time);
• The disposition date;
• The calculated holding period, demonstrating that each position exceeded the three-year threshold;
• The gain or loss realized on disposition;
• Cross-references to Ridgeline Securities LLC trade confirmations evidencing the acquisition and disposition transactions;
• Where applicable, an explanation of the methodology used to determine the holding period for positions acquired in multiple lots (i.e., FIFO or specific identification).
The analysis conclusively demonstrated that all fourteen positions exceeded the three-year holding period required by IRC § 1061 for long-term capital gain treatment. In several cases, the holding periods exceeded four or five years. The Ridgeline Securities LLC trade confirmations corroborated the acquisition and disposition dates set forth in the analysis.
IDR #4 — Organizational/Syndication Costs
August 4, 2023: IDR #4 was received from RA Albrecht. IDR #4 contained eight (8) items regarding the classification of costs as organizational expenses (deductible under IRC § 709(b)) versus syndication costs (non-deductible under IRC § 709(a)). The items requested, among other things:
• Copies of all legal invoices from counsel retained in connection with ICM's formation in 2016;
• A breakdown of the $1.42 million in total costs claimed, showing the allocation between organizational expenses ($680,000 deducted under IRC § 709(b)) and syndication costs (capitalized);
• Documentation supporting the classification of each category of cost;
• Ironside Capital GP LLC board or GP resolutions from the fund's 2016 formation documenting the expense allocation;
• Borwick Craine & Associates LLP workpapers supporting the deduction claimed on the 2021 Form 1065.
August 18, 2023: Calderwood & Harkness submitted the response to IDR #4, consisting of a cover letter accompanied by documentation supporting the classification of $680,000 as deductible organizational expenses under IRC § 709(b). The response included:
• Contemporaneous legal invoices from formation counsel (a separate law firm that represented ICM during its 2016 formation) that clearly delineated activities related to the creation of the partnership (organizational costs) from activities related to the marketing and sale of partnership interests (syndication costs);
• Ironside Capital GP LLC board resolutions from June 2016 documenting the allocation rationale at the time of the fund's formation;
• A narrative explanation distinguishing the $680,000 in organizational costs (including costs of drafting and filing the Certificate of Limited Partnership, negotiating the LPA among the initial partners, obtaining the EIN, and establishing the fund's accounting and operational infrastructure) from the $740,000 in syndication costs (including costs of preparing the private placement memorandum, investor marketing materials, and subscription agreements), which had been properly capitalized;
• Borwick Craine & Associates LLP workpapers corroborating the classification and the amortization schedule claimed on the 2021 Form 1065.
C. In-Person Meeting — IRS Manhattan Campus
July 14, 2023: An in-person meeting was held at the IRS Manhattan Campus, 290 Broadway, New York, New York 10007. The meeting was convened at the request of the IRS examination team and took place in a conference room on the 12th floor. The meeting lasted approximately two and one-half hours.
Attendees:
• Calderwood & Harkness LLP: Sylvia Hartwell, Partner; Leila Nazari, Associate
• IRS Revenue Agents: Timothy J. Albrecht (Lead Examiner); Dawn M. Petrovic (Supporting Agent)
• IRS Office of Chief Counsel: Eric S. Lundgren, Attorney, Large Business & International, Branch 5
The discussion covered all three issues under examination. The key points of discussion are summarized below:
Management Fee Waiver — IRC § 707(a)(2)(A). The IRS team raised preliminary concerns regarding the $23.8 million management fee waiver. RA Albrecht questioned whether the arrangement was primarily motivated by a desire to convert ordinary income (management fees) into long-term capital gain, and whether the GP bore genuine entrepreneurial risk. IRS Counsel Lundgren raised the framework set forth in Treasury Regulations § 1.707-2 and the legislative history of IRC § 707(a)(2)(A), focusing on the factors relevant to determining whether a purported allocation and distribution should be treated as a transaction described in Section 707(a). Ms. Hartwell responded by detailing the economic substance of the arrangement, including the genuine downside risk exposure borne by the GP, the contemporaneous documentation of the business rationale, the historical pattern of fee waiver elections, and the distinguishing characteristics of ICM's arrangement from the types of abusive fee conversion structures that have been the subject of IRS enforcement actions. Ms. Hartwell noted that ICM's fee waiver arrangement was structured in accordance with prevailing industry practice and was supported by the same types of contemporaneous documentation and risk analysis that the IRS has indicated it expects to see in connection with fee waiver arrangements.
Carried Interest Holding Period — IRC § 1061. IRS Counsel Lundgren questioned the holding period documentation for the fourteen positions identified in IDR #3. Specifically, Mr. Lundgren inquired about the methodology used to determine holding periods for positions acquired in multiple lots, the reliability of the Ridgeline Securities LLC trade confirmations, and whether ICM's internal records were consistent with the prime broker's records. Ms. Nazari responded by walking the IRS team through the trade-level holding period analysis and confirming the consistency of ICM's records with the Ridgeline confirmations. Mr. Lundgren also raised a question regarding whether any of the fourteen positions had been subject to hedging transactions or other derivative arrangements that might affect the holding period calculation under IRC § 1092 or other provisions. Ms. Hartwell confirmed that none of the fourteen positions had been subject to straddle or hedging arrangements that would toll or restart the holding period.
Organizational/Syndication Cost Classification — IRC §§ 709 and 195. RA Albrecht raised questions about the methodology used to allocate costs between organizational and syndication categories, noting that certain invoices from formation counsel contained line items that could arguably be classified in either category. Ms. Hartwell responded by referencing the contemporaneous GP resolutions and the Fenwick Craine workpapers that documented the allocation rationale at the time of the fund's formation in 2016. The IRS team appeared to be less focused on this issue relative to the first two issues.
Action Items: At the conclusion of the meeting, the following action items were identified:
• Calderwood & Harkness would prepare and submit a comprehensive legal memorandum addressing all three issues, consolidating the legal analysis with supporting statutory authority, Treasury Regulations, legislative history, case law, and IRS guidance.
• Calderwood & Harkness would provide any supplemental trade-level holding period documentation from Ridgeline Securities LLC requested by the examination team in connection with the IRC § 1061 issue.
D. Comprehensive Legal Memorandum
September 6, 2023: Calderwood & Harkness submitted a comprehensive legal memorandum to Revenue Agent Albrecht and IRS Counsel Lundgren, addressing all three examination issues in a single consolidated document. The memorandum was approximately 48 pages in length, exclusive of exhibits, and was structured as follows:
Section I: Management Fee Waiver ($23.8M) — IRC § 707(a)(2)(A). This section presented a detailed legal analysis of the management fee waiver arrangement under the disguised payment for services provisions of IRC § 707(a)(2)(A) and the related Treasury Regulations at § 1.707-2. The memorandum set forth the six-factor test under Treasury Regulations § 1.707-2(c) for determining whether a purported allocation and distribution to a partner should be treated as a transaction described in Section 707(a), and applied each factor to the facts of ICM's arrangement. The memorandum argued that ICM's fee waiver constituted a genuine entrepreneurial risk arrangement in which the GP assumed bona fide downside exposure through its increased capital interest, and that the arrangement was distinguishable from abusive fee conversion structures in which the partner effectively retains the economic equivalent of a guaranteed payment. The analysis cited relevant legislative history, including the 1984 Senate Finance Committee Report, and discussed IRS guidance and published rulings addressing fee waiver arrangements. The memorandum also addressed and distinguished several adverse cases and IRS enforcement positions involving fee waiver arrangements that lacked the indicia of genuine entrepreneurial risk present in ICM's arrangement.
Section II: Carried Interest Holding Period ($38.7M) — IRC § 1061. This section presented the statutory framework of IRC § 1061, as enacted by Section 13309 of the Tax Cuts and Jobs Act of 2017, and the final Treasury Regulations under § 1.1061-1 through -6 (issued in January 2021, effective for tax years beginning after December 31, 2017). The memorandum set forth the trade-level evidence for each of the fourteen challenged positions, demonstrating that each position satisfied the three-year holding period required for long-term capital gain treatment. The analysis addressed the applicable holding period rules, including the application of IRC § 1223 and the treatment of positions acquired in multiple lots. The memorandum also addressed IRS Counsel Lundgren's question from the July 14 meeting regarding straddle and hedging provisions, confirming that no such arrangements affected the holding period of any of the fourteen positions.
Section III: Organizational/Syndication Cost Classification ($680K of $1.42M) — IRC §§ 709 and 195. This section analyzed the distinction between organizational expenses (deductible under IRC § 709(b)) and syndication costs (non-deductible under IRC § 709(a)) under the applicable statutory provisions, Treasury Regulations, and case law. The memorandum argued that the $680,000 in costs classified as organizational expenses were incurred in connection with the creation of the partnership—specifically, the drafting and negotiation of the partnership agreement, the filing of organizational documents, and the establishment of the fund's operational and accounting infrastructure—and were not incurred in connection with the issuing and marketing of partnership interests. The analysis cited Revenue Ruling 85-32, the legislative history of IRC § 709, and several Tax Court decisions addressing the organizational/syndication cost distinction.
The memorandum was accompanied by a table of authorities and an exhibit index cross-referencing the factual documentation previously produced in connection with IDRs #1 through #4.
E. Follow-Up and Closing
September 22, 2023: A follow-up telephone conference was held between Sylvia Hartwell (Calderwood & Harkness), Timothy J. Albrecht (Lead Examiner), and Eric S. Lundgren (IRS Counsel). During this call, the IRS team communicated its preliminary views on the three issues. RA Albrecht indicated that the examination team had reviewed the comprehensive legal memorandum and the supporting documentation, and that the team's preliminary conclusion was that the positions reported on the 2021 Form 1065 were supportable. Mr. Lundgren indicated that he had consulted with his supervisory attorney in Branch 5 and that the legal analysis presented in the memorandum was persuasive on all three issues. RA Albrecht stated that he would discuss the matter with Territory Manager Karen P. Driscoll and would communicate the final determination in due course.
October 3, 2023: RA Albrecht contacted Leila Nazari by telephone to notify Calderwood & Harkness that the examination would be closed without adjustment. RA Albrecht confirmed that Territory Manager Driscoll had approved the no-change determination, and that a formal no-change letter would be issued.
October 14, 2023: The IRS issued Letter 4396-A (no-change letter) to Ironside Capital Management LP. The letter was signed by Revenue Agent Timothy J. Albrecht under the authority of Territory Manager Karen P. Driscoll and confirmed that the examination of ICM's 2021 Form 1065 was closed with no changes to the partnership return as filed. No Form 8986 (Partner's Share of Adjustment) was issued, no computational adjustments were proposed, and no penalties were asserted. A copy of the no-change letter was transmitted to Calderwood & Harkness on the same date.
Upon receipt of the no-change letter, Calderwood & Harkness notified ICM of the result by letter dated October 14, 2023, addressed to Marcus Trent, with copies to Desmond R. Calloway and Priya Venkatesh. The letter recommended that ICM notify Borwick Craine & Associates LLP (Elliot Navarro) of the no-change determination for purposes of their records.
F. Summary of IDR Production
The following table summarizes the Information Document Request activity during the course of the examination:
All IDR responses were submitted timely, and no IDR enforcement procedures were invoked by the examination team during the course of the engagement.
IV. Issues Examined and Resolution
This section provides a detailed analysis of each of the three issues examined by the IRS, including the amounts at issue, the IRS's position, the potential tax impact, the defense presented, and the final resolution.
A. Issue 1: Management Fee Waiver / Conversion — IRC § 707(a)(2)(A)
Amount at Issue: $23.8 million. This amount represents the management fees waived by Ironside Capital GP LLC during the 2021 tax year in exchange for an increased capital interest in ICM.
IRS Position: The IRS examination team took the preliminary position that the management fee waiver constituted a disguised payment for services under IRC § 707(a)(2)(A). Under this theory, the waiver arrangement was, in substance, a mechanism to convert ordinary income (management fees, which would be taxable to the GP and its members as ordinary income at rates up to 37%) into long-term capital gain (which would be realized upon the subsequent appreciation of the additional capital interest and taxable at the 20% long-term capital gains rate). The IRS sought to recharacterize the $23.8 million as ordinary income to the GP for the 2021 tax year.
Potential Tax Impact: Approximately $4.95 million across all affected partners, calculated as follows:
• Rate differential: $23.8 million × 17% (the spread between the 37% maximum ordinary income tax rate and the 20% long-term capital gains rate) = $4,046,000.
• Net investment income tax: $23.8 million × 3.8% (the additional Medicare surtax under IRC § 1411, applicable to net investment income of high-income taxpayers) = $904,400.
• Total potential tax impact: approximately $4,950,400.
Defense: Calderwood & Harkness's defense rested on several interrelated grounds:
First, the arrangement was structured as a genuine entrepreneurial risk arrangement in which the GP bore bona fide downside exposure. The GP's waiver of $23.8 million in management fees was irrevocable, and the GP received in exchange an increased capital interest that was subject to the same investment risks as all other capital interests in ICM. If ICM's investments declined in value, the GP's additional capital interest could be worth less—potentially substantially less—than the management fees foregone. This downside risk was real and documented, and it distinguished ICM's arrangement from structures in which the partner retains the economic equivalent of a guaranteed payment.
Second, the arrangement was supported by robust contemporaneous documentation, including the side letter agreement, the GP Resolution, and the contemporaneous memorandum prepared by Priya Venkatesh, all executed or prepared at or near the time of the fee waiver election. This documentation established the business rationale for the election, the economic analysis of the risks involved, and the arm's-length nature of the arrangement.
Third, the analysis under Treasury Regulations § 1.707-2(c) weighed in the taxpayer's favor on each of the six factors, including: (i) the allocation was not reasonably certain to be made; (ii) the allocation was not capped at a reasonable rate of return on invested capital; (iii) the allocation was subject to significant entrepreneurial risk; (iv) the GP's interest in future profits was meaningful and not merely nominal; (v) the arrangement was related to the ongoing activities of the partnership; and (vi) the arrangement did not constitute a transaction between the partnership and a partner acting in a non-partner capacity.
Fourth, Calderwood & Harkness distinguished ICM's arrangement from the types of abusive fee conversion structures that have been the subject of adverse judicial decisions and IRS enforcement activity, emphasizing the genuine risk of loss and the absence of the hallmarks of a disguised payment.
Result: No adjustment. The IRS accepted ICM's position on this issue. The $23.8 million management fee waiver was respected as a valid capital contribution arrangement, and no recharacterization as a disguised payment for services was made.
B. Issue 2: Carried Interest Holding Period — IRC § 1061
Amount at Issue: $38.7 million. This amount represents the portion of the $94.3 million in total performance allocations to the GP that was attributable to the fourteen positions challenged by the IRS.
IRS Position: The IRS examination team questioned whether the fourteen positions liquidated during 2021 that contributed to the $38.7 million in challenged performance allocations satisfied the three-year holding period required by IRC § 1061 for long-term capital gain treatment. Under IRC § 1061, gain allocable to an "applicable partnership interest" (as defined in § 1061(c)) is treated as short-term capital gain to the extent that the gain is attributable to assets held for three years or less. The IRS sought to reclassify the $38.7 million from long-term capital gain to short-term capital gain, which would result in taxation at ordinary income rates rather than the preferential 20% long-term capital gains rate.
Potential Tax Impact: Approximately $6.579 million, calculated as $38.7 million × 17% (the spread between the 37% maximum ordinary income tax rate applicable to short-term capital gains and the 20% long-term capital gains rate).
Defense: Calderwood & Harkness presented a comprehensive trade-level holding period analysis, prepared by Robert Jansen and reviewed by Leila Nazari and Sylvia Hartwell, demonstrating that each of the fourteen challenged positions exceeded the three-year holding period required by IRC § 1061. The defense included:
• Detailed schedules identifying each of the fourteen positions by security name, CUSIP/ISIN, and description, together with the acquisition date(s), disposition date, calculated holding period, and realized gain for each position.
• Cross-references to Ridgeline Securities LLC trade confirmations evidencing the acquisition and disposition transactions, which independently corroborated the holding period calculations set forth in the analysis.
• An explanation of the holding period methodology, including the use of specific identification for positions acquired in multiple lots, consistent with the fund's established accounting policies and the requirements of Treasury Regulations § 1.1061-4.
• Confirmation that none of the fourteen positions was subject to hedging, straddle, or other derivative arrangements that could affect the holding period under IRC § 1092 or related provisions, as specifically raised by IRS Counsel Lundgren during the July 14 meeting.
• An analysis of the applicable statutory and regulatory framework, including IRC § 1061(a), (c), and (d), Treasury Regulations §§ 1.1061-1 through -6, and the holding period rules of IRC § 1223.
The analysis conclusively demonstrated that the shortest holding period among the fourteen challenged positions was three years and four months, and the longest was five years and seven months. There was no basis for the IRS's initial concern that any of the positions failed to meet the three-year threshold.
Result: No adjustment. The IRS accepted ICM's position on this issue. All $38.7 million in challenged performance allocations were properly treated as long-term capital gain under IRC § 1061.
C. Issue 3: Organizational and Syndication Cost Deductions — IRC §§ 709, 195