- Fundamentals
- Posts
- 💰️ Investment Fund Tax Planning, Part 2: Pass-Throughs vs. C-Corps
💰️ Investment Fund Tax Planning, Part 2: Pass-Throughs vs. C-Corps
The two most common tax classifications in investment funds and syndications

Happy Friday, Funds Family!
Today is Part 2 in our investment fund and syndication tax series. Buckle up!
Last week, we discussed high-level tax planning, including types of taxes and different goals of GPs and LPs. Today, we’ll discuss the differences between pass-through entities and c-corporations (C-Corps) for tax purposes.
As in our last article, “tax” refers to U.S. federal income tax unless we specify a different type of tax.
But first…
/ SELF PROMOTION

If you’re a general partner (GP) raising an investment fund or syndication in private equity, private credit, real estate, or venture capital, we may be a good fit for you. We also represent limited partners (LPs) investing in funds and syndications.
Thanks for reading, now we are ready to dive into the article 😃
🔀 Tax treatment versus legal entity type
First, let’s clear something up. Tax structuring can get confusing because sometimes an entity’s “legal” type is different from its “tax” type. 🫠
For example, a Delaware limited liability company may be classified for U.S. federal income tax purposes as a partnership, a disregarded entity, a C-Corp, or an S-Corp! For some business entities, the tax classification is elective. For others, it’s mandatory.
Examples of forms you can use to change the tax classification of entities include 🔗Form 8832 (electing corporation or partnership/disregarded entity status) and 🔗Form 2553 (electing S-corp status). 📄
📜Pass-through entities (for tax purposes)
Pass-throughs include partnerships, disregarded entities, and S-Corps. Most pass-through entities in fund structures are “partnerships” for tax purposes or “disregarded entities.” Let’s look at two key characteristics of pass-through entities. 🔍️
💵 Single-level taxation (i.e., no double taxation)
Pass-through entities generally do not pay tax at the entity level – rather, the income or loss “earned” at the entity level “passes through” to the entity’s owners and is allocated among them according to their ownership interests. 🧮
For a fund, this is a complex allocation based on the investors’ and principals’ rights to distributions (i.e. the "🛠️Carried Interest" ).
Entities taxed as partnerships send K-1s to their “partners” each year detailing their allocable tax items. Then, the partners integrate these K-1s into their personal tax returns. Depending on the information in the K-1, the partners might pay tax on allocable income/gain or receive tax losses they may be able to use to reduce other taxable income.
👻 Boo!...beware of “phantom income”
Phantom income is a spooky business. In a particular year, a pass-through entity might earn income that it doesn’t actually distribute to the partners. In this case, the owners may owe tax on this “phantom income” without receiving cash to pay it. 😬
Phantom income can result from the reinvestment of earnings, the establishment of reserves, or circumstances that produce taxable income without cash flow (e.g. “deemed interest” on certain debt instruments).
Funds often include special tax distribution provisions to help investors pay their tax liability.
🚦 Character and Activity Pass-Through
Pass-throughs “pass through” the character of income, gain, or loss to their owners (including long-term capital gains, dividends, and QSBS).
The activity of a pass-through can also be attributed to its owners – this can be especially important for non-US investors, as we’ll discuss in a future article. In short, this could cause non-U.S. investors to be treated as engaged in a U.S. trade or business and may force them to file a U.S. tax return. ☹
📜 C corporations (for tax purposes)
Alright, let’s move on to C-Corps.
💸 Double-taxation
The big downside of C-Corps is “double taxation.”
First, C-Corps may owe tax at the entity level. The current top marginal U.S. federal income tax rate on C-corps is 21%. Next, a second level of tax may apply to the C-Corp’s equity owners when they receive distributions or sell their equity in the C-Corp.
🚦 Character and Activity Blockers
Character and activities generally do not pass through to C-Corp owners. Ordinary and capital gains income is taxed at the same C-Corp tax rate and activities like U.S. trade or business activity are “blocked” from attribution to non-U.S. owners, which is why C-Corps are sometimes referred to as “blockers” in the fund tax world. 🛡️
U.S. funds and syndications don’t use C-Corps entities as often as pass-throughs. However, C-Corps may be helpful in certain special scenarios, such as in “blocker” tax structures to accommodate non-U.S. or U.S. tax-exempt investors.
🌎️ US versus non-US entity types
Pass-through entities and C-Corps may be U.S. or non-U.S. entities. Note that each country has its own system of entity tax classification that may differ from the U.S. pass-through/C-Corp dichotomy.
U.S. entities are generally cheaper and easier to form and administer than most non-U.S. jurisdictions. Therefore, the U.S. (Delaware in particular) is a popular jurisdiction for funds and syndications. ✅
However, in some scenarios, the tax savings may lead funds to set up non-US entities (taxed as pass-throughs or C-Corps, depending on the circumstances. We’ll discuss non-US entities in a future article.
Thanks for reading! Next week, we’ll review a standard fund set up for tax purposes. Hint: It will involve pass-through entities. 🤫
/ WRAPPING THE CASE
![]() |
|
Thanks for reading, everyone.
Have a great weekend! 🙌
/ ABOUT THE CO-AUTHOR
Adam Krotman

Adam is a tax and transactional investment funds attorney with extensive experience advising funds, investors, and family offices in both an in-house and outside counsel capacity. In addition to his tax counsel role advising on fund formations at The Investments Lawyers, Adam is a partner at Transition Point Law, where he co-launched a Fractional GC+ Service focused on outside general counsel support for investment fund and family office clients throughout their life cycles. His prior career experience includes stints as a “big law” attorney, in-house counsel at Amazon, and general counsel at an emerging venture fund manager and international family office. Outside of tax and investment funds, Adam enjoys family time, adventures in the mountains, and travel.
You can reach Adam directly with any questions or inquiries at [email protected].
/ JURY TRIAL
How did you like today's post? |
Have you enjoyed this newsletter? Don’t forget to share it with your GP, Co-GP, LPs, or anyone else you think might find it valuable!
You can also propose a topic that you would like us to cover! Just reply to this email or submit your suggestions 🔗 here.
⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.
Reply