Getting Your Investment Club Up and Running

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In last week’s post, I discussed why and how you might consider starting an investment club. In this week’s post, I describe the nuances of running an investment club and how to deal with club business matters such as accounts and taxes. These items exist because anytime you have a business entity that is making money, the law and (especially) the IRS will be very interested in your club’s dealings.

The EIN

Once you have named your investment club and its officers, you will need to obtain an employer identification number (EIN), which will be used when you file the club’s tax return. The EIN is, in essence, like a social security number that identifies your club as a unique entity to the IRS. Despite its official sounding jargon, the EIN can be obtained in a matter of minutes by going to  the IRS website and filling out Form SS-4. You can also call 1-800-tax-form (1-800-829-3676) for help.

Club accounts

It is imperative that you open one or several bank accounts in the investment club’s name and use them solely for the purposes of club business. Unless your investment club forms an LLC, you will first need to obtain a “doing business as” or DBA (i.e., Registration of Firm Names) document from your local city hall. Click the following link for more information about how to obtain a DBA. This will allow your club to be recognized as a business entity on bank and other accounts.

If your club starts investing in equities (e.g., stocks), you will also need to open one or more brokerage accounts also in the club’s name. Some brokerages may charge significant fees to facilitate equity transactions like stock purchases. To this end, you and your club partners may want to look into becoming members of the National Association of Investors Corporation (a.k.a. Better Investing), a non-profit organization which provides its members with discounts on stock trades. The NAIC also offers a wealth of educational materials, accounting software and legal forms.

And now for the not-so-fun stuff…

Filing tax returns as a club

Filing club taxes is usually the duty of the club’s treasurer and can be a stressful task for him or her; however, by following these guidelines, the process should become simpler with time (and more rewarding if followed by several gifts of beer from other club members). To begin with, the investment club, if formed as a “pass-through entity” (e.g., partnership), is not required to pay federal or state taxes. Instead, all club partners are expected to report their investment profits (or losses) on their personal tax returns. Still, just because the club itself is exempt from paying taxes doesn’t mean it gets off scot-free; investment club treasurers must file an information return, called Form 1065 (U.S. Return of Partnership Income), each year by the April 15th deadline. Furthermore, if even one of the club’s partners resides in a state other than that of the investment club, the treasurer should contact that state to find out if it requires its own return (e.g., IL-1065 for Illinois) as well.

Keep in mind that Form 1065 is applicable to all kinds of partnerships and not just investment clubs. In fact, the majority of Form 1065 has nothing to do with investment clubs. Thus, especially if this is your first year gathering partner data and filing out the form, it may be better to utilize the services of a tax professional or accountant. Alternately, the NAIC provides tax software that can easily track club investments, profits and forms for each partner.

Each club partner must be provided with a Schedule K-1 which details that partner’s investment profits, costs and transactions. As such, the K-1 is akin to Form 1099 which brokerages and other financial institutions send to their clients each year. Unlike the Form 1099, though, which has a “send-by” deadline of February 15th, the K-1’s “send-by” deadline is actually April 15th- yes, April 15th. This is because the IRS realizes that investment clubs may need extra time to gather up investment materials as well as all the 1099 forms from their brokers (at which point they can file for an extension). However, if you, as the club treasurer, decide to wait until the morning of April 15th to notify fellow club members about how much they owe the IRS on their personal returns, you may end up with several of those members never speaking to you again. So, DON’T wait until April 15th. Ideally, given that all the 1099 forms should be received by February 15th, your investment club should shoot for a K-1 “send-by” deadline of late February.

Club partner expectations

Once all the legal and tax obligations are settled, your investment club’s success will depend on each partner fulfilling his or her obligations to the club. In most cases, those obligations are as follows:

1. Attend all club meetings.

2. Pay club dues.

3. Research current and pending club investments.

Each club partner should understand that the investment club is a business and, like any business, will probably not see a profit in its first few years of operation. Thus, any partner who decides to “cash out” of the club cannot expect to get back all the money that he or she originally invested. There is also the matter of trust in the formation of an investment club: Since you are going into business with 15 or so other individuals, you should be able to trust those individuals (and vice versa). Hopefully, you will also like your partners and enjoy their company as you consider your mutual investments and learn from one another. After all, these are the end purposes of forming an investment club.

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2 Comments

  1. I would say there are definitely advantages to getting a lawyer, he could look at the document and make recommendations. While getting a document notarized is good, but according to a search of internet notarizing does not make it a a legal and binding agreement that would hold up in court if someone were to challenge it.

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  2. Hello! I’ve been doing a lot of research on investment clubs, as my friends and I are currently working on starting one. We have worked on the partnership agreement extensively and we think we are happy with it. The members went through and voted on each clause. We also have elected what we are calling a Board, and collected the first round of dues. But, we are wondering if we should contact a lawyer before getting it notarized or if this would just be a waste of funds at the beginning? Are there significant advantages to getting a lawyer?

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