Author Topic: Individual corporate bonds: Reducing investment income by being a Fund Manager?  (Read 1459 times)

Weathering

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Hi,
I absolutely love purchasing corporate bonds as a source of income (and appreciation sometimes or growth through reinvesting). However, my hobby of buying/holding bonds has negative implications on my taxes compared to buying/holding stocks. I am nearing the end of a fun corporate career and will be looking into whether or not I could lower my taxes by declaring on my taxes and proving that my profession is that of a fund manager.

So as I start looking into this I thought that I'd ask here if anyone is doing this or knows how it would be done? For example, could the income from these bonds be considered dividends from a fund (which is, I think, the way hedge fund managers only pay 15% tax on their $M income.)

I know that for Real Estate investments there is a difference between being an active Real Estate Professional vs being a passive Real Estate Investor (the difference is based on spending ~2000 hours per year on Real Estate). I would be looking into whether something similar is possible for my infatuation with individual corporate bonds. I've even looked into forming a bank with my investments - the minimum threshold on capital necessary to form a bank is only $1M so it isn't as high as one might think.
Any thoughts would be greatly appreciated (just don't call me a dreamer because my dreams came true long ago, and don't bash my obsession with bonds because it isn't something that I can change - if I sold all my bonds today and went 100% to stocks then I would be out on the streets buying bonds again before the sun rises tomorrow).

SeattleCPA

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...which is, I think, the way hedge fund managers only pay 15% tax on their $M income....

Let me address this one element of your post...

If you are a partner in a partnership (e.g., you are a partner in a hedge fund), you get a share of the income or the deductions generated by the partnership.

This is the key thing people don't understand: Those income and those deductions retain their character as they "pass through" to your return.

E.g., if you owned 50% of a partnership with a $10,000 charitable contribution deduction and a $100,000 long-term capital gain, you would get a $5,000 charitable contribution from the partnership and a $50,000 long-term capital gain from the partnership to put on your tax return. And these amounts get treated on your 1040 return in the usual way. Just as if you'd experienced them yourself.

So when do you get to pay at the 15% rate? That tax rate simply occurs when the income that's passed through is taxed on the individual's return at 15%... E.g., when the income is long-term capital gains taxed at 15%. Or qualified dividends.

In short, there's nothing magical going on here. It's just basic partnership accounting.

P.S. Hedge fund managers would not now pay a 15%... that's out of date. Their long-term capital gains rate would surely be 20%... and they'd also pay the 3.8% net investment income tax (aka Obamacare tax)... and then probably state income taxes too since they're in NY or CT or CA.

Weathering

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I lost my obsession with bonds last year (sold nearly all except a few munis, and some corporates in an IRA). This was because the yield on bonds became ridiculously low. For example, the vanguard high yield bond fund offered a yield below 3% in Q3 2021.

But I’m now getting ready for when corporate bonds offer a yield above inflation. I think this will happen in early 2023 and last for less than five years (a short window). This will again result in a negative impact on my taxes (40% tax rate on interest income or non-qualified dividends when considering federal plus state).

So I’ll be thinking of the best corporate structure to make bonds my business, not to reduce taxes but to defer them if possible.