Massachusetts Tax Authorities Present Draft Directive on Trader vs. Investor Funds


The Massachusetts Department of Revenue has circulated a draft Directive setting forth the standards the Department proposes to impose for determining whether a professionally-managed fund is a “trader” or “investor” for Massachusetts personal income tax purposes. The Department has invited comments on the draft Directive to be submitted by July 20, 2011.

The classification of a fund as a trader or investor has important implications for a U.S. individual investor’s ability to deduct management fees and certain other expenses of the fund, for both federal and Massachusetts income tax purposes. A U.S. individual investor in a "trader" fund may deduct these expenses as “trade or business” expenses. For federal income tax purposes, however, a U.S. individual investor in an “investor” fund must treat these expenses as investment expenses that are “miscellaneous itemized deductions.” For federal income tax purposes, a U.S. individual investor can deduct miscellaneous itemized deductions from all sources only to the extent they exceed 2 per cent of the investor’s adjusted gross income for the year in question. For Massachusetts personal income tax purposes, no deduction is allowed for investment expenses. In addition, only a trader fund can elect to report income on a mark-to-market basis for federal income tax purposes. Finally, the distinction between trader and investor may also influence the manner in which the general partner’s incentive allocation or incentive fee can be structured.

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