While investing great way to grow your assets and lay the foundation for financial freedom, it comes with one certainty: 

If you make a profit, it will be taxed.

While tax season may be everyone’s least favorite time of the year, paying taxes on profits is still a preferable alternative to not making a profit. While most investors (particularly younger investors from Gen Y and Gen Z) want to jump right to the question of what is owed, let’s first look at which forms you are likely to receive come tax time. 

This will help you better understand your tax liability.

So let’s assume you’re in the money, and are curious about what tax forms may apply to your investment(s). I’m happy to provide some general information and hope you find them helpful, but first, a message from our sponsor…

We interrupt our normal programming to make sure you know Vicinity cannot give you tax advice and will likely not be the entity providing tax documents to you. Individual situations will vary, and you should consult your CPA.

Ok–with that out of the way, let’s take a look at today’s topic: taxes for investors.

First, How Are Taxes For Investors Determined?

Tax liability is largely determined by the type of entity you invest in (either an LLC or a C-Corporation) and the type of security you receive (debt or equity).

The type of entity will be disclosed in a couple of places in an offering, but can always be found on the company’s Form C. If you are investing in a Reg CF offering through Vicinity, the issuer’s Form C will always be linked on the offering page.

It is important to note that while LLCs are typically taxed as a partnership, the company can elect to be taxed as a corporation. We won’t get into the details today, but you can learn more about entity classification from the IRS website.

Once you have an understanding of what kind of entity and security you invested in, you will have a better idea of what forms you will need to fill out. Let’s take a look at some examples.

Debt in an LLC or C-Corp: Form 1099

Debt in an LLC or C-Corp could refer to a number of different offerings or financial instruments:

It could be a term loan, revenue sharing note, or convertible note (before it converts). 

If you’ve received interest on your debt investments, you should receive a form 1099 from the company to include with your tax filings. 

In a nutshell, form 1099 can be described as a collection of tax forms that document the different types of payments made to you by a business other than your employer. There are several types of 1099s you might receive as an investor. With respect to interest income of more than $10, the form you will receive will be form 1099-INT.

A quick comment on revenue sharing notes.

These notes are classified as a contingent payment debt instrument since the interest on revenue-sharing investments cannot be calculated until actual payments are made. As such, the interest calculation is done at the end of the year when all payments for that year have been made. The form used for a Rev Share is generally a 1099-OID.

Equity in an LLC: Schedule K-1 Tax Form

Equity in an LLC would likely be in the form of membership interest in the company

If you made an equity investment or hold convertible notes that have converted, you should receive a Schedule K-1 tax form. This form is issued annually (typically by March 15 of each year) to report earnings and income from investments in a partnership or in an LLC.

The Schedule K-1 is typically issued by “pass-through” financial entities. This means that these entities don’t pay corporate tax on income, but shift any tax implications to their stakeholders. The purpose of the Schedule K-1 is to track and report on each participant’s share of an organization’s gains, losses, deductions, credits, and other distributions. This is often viewed as a favorable structure for real estate investments as there may be a beneficial offset of profits by depreciation.

To learn more about the Schedule K-1, check out this comprehensive article by Investopedia

Note that if you have invested in a SAFE (i.e., a Simple Agreement for Future Equity) or Convertible Note (before conversion), no Schedule K-1 will be due to you.

Equity in a C-Corp: It Depends

C-Corps, unlike LLCs, are considered “regular” corporations and not “pass-through” financial entities. This means that these entities pay taxes that are due on their gross income, not shareholders. They then distribute profit to their shareholders, who in turn pay income tax on dividends.

Equity or shares in a C-Corp will not be issued a Schedule K-1. Generally, investors will only need to report income when they realize a gain or loss for tax purposes (e.g., selling a position or earning interest). Again, this is unlike other business structures and is considered by many investors to be a major benefit of investing in C-Corps when investing in an operating business instead of real estate

If dividends were paid, you would receive a form 1099 (though this is uncommon for early-stage businesses).

A Few Final Points to Keep in Mind

Before we wrap up, there are a few final focus points to highlight when it comes to investments and taxes.

First, if you sold a security acquired on Vicinity in a private transaction and realized a gain, the capital gain is taxable.

Second, if you sold a security acquired on Vicinity in a private transaction and realized a loss, it would qualify as a capital loss and be used to offset capital gains you may have from other investments.

Finally, if the company you invested in goes bankrupt, the company is responsible for providing the tax documents to reflect any loss.

Vicinity: Diversify Your Portfolio, Invest Local

Ok–that’s it for today! You should now have a basic understanding of where to begin when it comes to the topic of taxes for investors.

While tax forms may not be the most exciting topic, understanding your tax obligations is crucial to building a successful investment portfolio, especially in these times of economic uncertainty. 

On that point, it’s important to remember that investing in your local community, particularly real estate, may help offset the volatility of current markets. This is especially true as traditional asset classes continue to lose money at significant rates. There are no guarantees, and alternative investments run the risk of loss as well. Take care to only invest what you can afford to lose!

If you want to learn more about how Vicinity is helping a new generation of investors build, support, and earn money from their local economy through Regulation Crowdfunding, reach out to us at [email protected], or sign up for the Vicinity platform here.