NY Makes the First Move
In light of the recent economic downturn, many states are looking for ways to supplement their budgets to overcome shortfalls by taxing additional types of property, goods and services.
In light of the recent economic downturn, many states are looking for ways to supplement their budgets to overcome shortfalls by taxing additional types of property, goods and services. It is not surprising that Governor Patterson’s Executive Budget recommendation for consideration by the New York State Legislature for 2009-2010 introduces several new taxes. While some of the proposed taxes (such as the tax on all digitally-delivered property) have received rigorous public debate, others have slipped under the radar of public attention. One provision receiving little attention is the proposed treatment of income received by nonresident partners for management services performed for investment partnerships or other entities (often referred to as "carried interests"). If such investment partnerships or entities conduct business in New York, the carried interest allocation to a nonresident partner will be New York source income subject to New York tax if the nonresident individual is a partner in a general partner entity and provides a substantial quantity of investment management services in New York to an investment fund.
For federal income tax purposes, carried interest income is characterized as capital gain (as opposed to ordinary income).
For federal income tax purposes, carried interest income is characterized as capital gain (as opposed to ordinary income). Typically, capital gain earned by nonresident partners is not New York source income. Instead, it is sourced to the partner’s state of residence.
The Memorandum of Support for the bill to tax the carried interests of nonresident partners argues that the proposed tax will equalize taxation of nonresident partners with that of resident partners performing the same investment management services. If passed, the proposed bill would amend Sec. 631(b)(1)(B) of the New York Tax Law to include investment management services to a partnership or other entity in New York as a business carried on in New York and would add new Sec. 631(h) that would require inclusion of payments received by the partners for performing investment management services in New York as New York source income.
The proposed Sec. 631(h) defines "investment management services to a partnership or other entity" to mean providing a substantial quantity of any of the following services to the partnership or other entity:
- Advising the partnership as to the value of any specified asset;
- Advising the partnership as to the advisability of investing in, purchasing, or selling any specified asset (including securities, real estate, commodities and options, or derivative contracts with respect to securities, real estate or commodities);
- Managing, acquiring, or disposing of any specified asset;
- Arranging financing with respect to acquiring specified assets;
- Any activity in support of any service described in (i) through (iv) above.
Further, the New York estimated tax requirements for partnerships (i.e., “withholding” on behalf of nonresident partners) would be modified to take this provision into account.
The NY legislature expects the passage of this bill to yield an additional $60 million of annual personal income tax revenue. If enacted, this legislation will have a significant impact on private equity and hedge funds that use carried interest allocations as incentive compensation for general partners. If passed, the bill would become effective for taxable years beginning on or after January 1, 2009.
