New York Governor’s Proposal to Tax Carried Interests Earned by Non-Residents

December 23, 2008

On December 16, 2008, New York Governor David A. Paterson included among his executive budget proposals a provision that would expand New York’s non-resident personal income tax to include carried interest investment income. If the Governor’s Budget Bill (S60/A160) (the “Bill”) is passed, effective January 1, 2009 income received by non-residents for performing “investment management services” for partnerships or other entities doing business in New York will be treated as New York source income taxable by New York State.

Under current law, a non-resident of New York State (other than a dealer) generally is subject to New York personal income taxation only on income derived by the non-resident from a trade or business conducted in New York (i.e., fee income); and, a non-resident is not treated as engaged in a trade or business in New York State solely by reason of the purchase and sale of property (e.g., stocks and securities) for his own account (i.e., incentive allocation income). As a result, a non-resident partner of an investment management partnership (or a limited liability company treated as a partnership for tax purposes) located in New York is not subject to New York personal income tax on his share of any incentive allocation derived from the securities trading activity of an investment fund in which the investment manager is the general partner. On the other hand, a non-resident partner of an investment manager is subject to New York State personal income tax on his share of any management fee and incentive fee income derived by the investment manager.

The statement in support of the Bill notes that a non-resident partner of an investment management partnership escapes New York State income taxation on an incentive allocation whereas resident partners in the same partnership are taxed on all of their income, including the incentive allocation they receive, from the partnership. The proposal is intended to result in “equal treatment of this income for residents and nonresidents.”

The Bill broadly defines “investment management services” to mean providing a substantial quantity of the following services: (i) advising as to the value of any specified asset; (ii) advising as to the advisability of investing in, purchasing, or selling any specified assets; (iii) managing, acquiring or disposing of any specified asset; (iv) arranging financing with respect to acquiring specified assets and (v) any activity in support of these services. “Specified assets” are securities, real estate, commodities or options or derivative contracts with respect to securities, real estate or commodities.

The proposal to expand the tax on non-resident hedge fund income is projected to raise an additional $60 million in taxes in each of the 2009-10 and 2010-11 fiscal years.

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