New York backtracks on carried interest tax hike

State legislators, after considering raising the tax rate on carried interest for managers that work in New York but live outside the state, have let the idea fall by the wayside.

A proposal to change to the tax code for fund managers who work in New York but live outside the state has quickly fallen out of favour and is unlikely to pass.

The plan to raise the tax on carry for non-residents of New York was first introduced in April 2008 but was recently revisited as the state is seeking new revenue to reduce its budget deficit. Proponents of the rule estimated that the tax increase would provide the state with an additional $50 million of revenue.

Private equity managers are currently taxed on their income by the state where they work and on their investment gains by the states where they live. Investment income in New York is subject to the same tax rate as other income like salary, so managers who live in New York have already been paying state tax on it.

If New York reclassified carried interest, it would tax nonresident managers as if their carried interest is no different from any other kind of fee paid for work performed. And if Connecticut does not follow New York in reclassifying carried interest as ordinary income, private equity managers who work in New York could be taxed by two states on the same profits.

New York City Mayor Michael Bloomberg came out strongly against the proposal this week, saying that private equity and hedge funds will move their operations to nearby Connecticut. Many Wall Street professionals already work in New York City but commute from nearby towns in Connecticut, including Greenwich, a major hedge fund hub.

“I think it's the best thing that ever happened to Connecticut,” Bloomberg told reporters this week. “I can't imagine why every hedge fund won't pick up tomorrow and leave.”

Connecticut Governor Jodi Rell seized on the opportunity to capitalise on the tax proposal.

“As lawmakers in Albany consider a proposal to vastly increase the tax liability of hedge fund professionals who work in New York, many of whom have already wisely decided to live in Connecticut, I would like to convey a very simple, yet heartfelt, message: Connecticut welcomes you,” Gov. Rell wrote in a letter to hedge fund managers.

The proposal has been included in a budget bill that had been supported by the state legislature. New York state's highest income tax rate of 8.97 percent for people who earn more than $500,000 a year tops the equivalent income tax rate of 6.5 percent in Connecticut.

A tax hike on carried interest at the federal level has repeatedly failed in the US Congress thus far. The most recent attempt stalled in the Senate last month.