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PwC alternatives alert, July 8, 2010
New York State introduces carried interest legislation
On June 29th, 2010, the New York State Legislature introduced legislation (A09710D; S6610-C) to expand New York's non-resident personal income tax to include general partnership incentive allocation income, which is also referred to as "carried interest" allocations. If this Budget Bill provision is passed, income received by non-resident partners 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, effective January 1, 2010. Governor David Paterson originally introduced this legislation in January of 2009, and it has been included in his Budget bill, as well, signaling that this provision is most likely to pass.The Budget Bill treats the carried interest as business income received from a trade or business carried on by the taxpayer. Therefore, if the incentive allocation income arises from the sale of securities, that piece of the incentive allocation income would now be taxable in New York for non-residents. Historically, the income would have been taxed only in the partner's resident state. Since New York State does not have different rates for types of income (ordinary vs. capital gain), any amount of the carried investment income apportionable to New York would be taxed at the rate of 8.97%.
Furthermore, non-resident shareholders of a New York S-corporation, which provides investment management services to a partnership, as well as corporate partners in partnerships that provide investment management services will be impacted by the new legislation. The carried interest will be deemed will be taxed as business income rather than investment income. Generally, investment income is preferentially allocated to New York State using an investment allocation percentage.
The Budget Bill defines "investment management services" to mean providing a substantial quantity of the following services: (i) advising as to the advisability of investing in, purchasing, or selling any specified assets; (ii) managing, acquiring or disposing of any specified asset; (iii) arranging financing with respect to acquiring specified assets; and (v) any activity in support of these services. The term "specified asset" means securities, real estate, commodities or options or derivative contracts with respect to securities, real estate or commodities.
Unlike the originally proposed legislation, there is a new carve-out on the carried interest for private equity real estate funds. A partner or shareholder will not be deemed to be providing investment management services if at least 80% of the average fair market value of the specified assets of the fund during the taxable year consists of real estate.
There are numerous questions that remain unanswered by the proposed legislation. They include:
- How will the apportionment of the carry be determined? Will it be based on where the partners of the general partner vehicle performed their services or will the investment manager's services in NYS taint/impact the apportionment calculation? This may become a detailed calculation for investment managers with multiple offices.
- Will other states provide a resident credit for the taxes paid to New York State on the carried interest portion? It seems that under current NJ law, it would be provide a credit, however, CT and CA seem unlikely to provide a credit. With the states' budget deficits the states may seek to limit the credit for their residents.
- Will there be any limitations on capital loss carry forwards to be utilized if New York State attempts to recharacterize the carry as ordinary income?
For additional information, please contact your PwC engagement team or any of the partners in our practice.
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