The Most Common Audit & Tax Mistakes Fund Managers Make (And How to Avoid Them)

 

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You’ve got the strategy nailed down. The docs are drafted. You’re ready to launch your fund. Then reality hits: a 14-week audit cycle instead of six weeks, shocked LPs receiving unexpected tax bills, and frantic calls about missing cost basis data from last year’s Bitcoin contributions.  

These aren’t hypothetical scenarios. They’re the most common pitfalls that derail promising fund launches every year. The good news? They’re completely preventable. Steve Vlasak and Jon Sharon, Partners in Richey May’s Alternative Investments Practice, recently sat down with Alt Funds Network to pull back the curtain on what actually goes wrong and how to avoid it. Whether you’re launching your first fund or managing your tenth, their insights could save you months of headaches and thousands in unnecessary costs. 

Understanding the Audit Function and Timing

Auditors verify financial statement numbers for GAAP or IFRS compliance across five key areas: completeness, obligation, valuation, existence, and reporting. This involves tracing expenses and transactions, sending independent confirmations to banks and brokers, and verifying valuations through third-party sources like Bloomberg and CoinMarketCap for liquid assets. 

Timing is critical. Auditors should be engaged when draft formation documents like the LPA and PPM become available. For digital asset funds, early involvement establishes API connections with exchanges to capture data from day one, since many exchanges limit historical data access. 

Audit Requirements and Common Pitfalls

Audits are required for SEC-registered and NFA-registered funds, with additional state and offshore jurisdiction requirements. Beyond regulatory mandates, institutional investors view audits as essential for capital raising, often considering them a deal breaker. 

Steve identified several pitfalls that complicate audits. Inaccurate books can extend a typical four-to-six-week audit to 12 to 14 weeks. For funds holding private investments, establishing valuation policies at year-end rather than upfront creates complications, especially if adjustments contradict investor letters already distributed. Working with service providers who lack expertise in your strategy can lead to unnecessary questions and missed items. 

Tax Process and Timing

Jon Sharon explained that tax preparation involves close collaboration with fund administrators and, when applicable, Richey May’s audit team. The primary focus is preparing K-1s for limited partners. While partnership returns can be extended from March 15th to September 15th, the practical goal is issuing K-1s by March 31st, so LPs can file their personal returns on time. 

Digital Asset Tax Complexities

Accepting in-kind crypto contributions requires careful planning. When investors contribute Bitcoin or other digital assets, the fund must track original cost basis and holding period for each lot. If the fund uses that Bitcoin to purchase other tokens, it creates a taxable event for the contributing LP who may have expected tax deferral. 

Jon advised limiting in-kind contributions to larger investors, as the administrative burden of tracking multiple crypto contributions can become overwhelming relative to smaller contribution amounts. 

Key Takeaways

Communicate early and often. Fund managers should understand their K-1 implications before year-end and be prepared for situations where taxable income exceeds cash distributions. General partners often underestimate their own tax liability.  

Work with specialists, not generalists. Alternative investments require specialized expertise across all service providers. Generic approaches don’t work for digital assets, private equity, or other complex strategies.  

Engage before you launch. Review formation documents with your auditor before launch, establish clear valuation methodologies from the start, and plan your tax structure with both fund and LP implications in mind.  

Plan for gray areas. For complex transactions, particularly in crypto where regulations remain unclear, experienced tax preparers help fund managers understand different position options and associated risks.  

 

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Ready to avoid these common pitfalls? Contact Steve Vlasak, Partner in Alternative Investments at Richey May, to discuss your fund’s specific needs. Or explore our Insights page for additional resources on fund audits, tax strategies, and regulatory compliance.